For many people, buying is home is one of the biggest financial decisions they’ll make in their life. There are so many options to consider, but you may have finally been leaning towards a fixed-rate home loan. However, you maybe ask yourself what exactly are fixed-rate home loans, what are the advantages and disadvantages, and why are they so popular?
What is a fixed-rate home loan?
A fixed-rate home loan is fairly simple and straightforward. Your mortgage will have an interest rate that is locked for the life of the loan. Your monthly payment will never change and remain for the next 15 or 30 years, depending on the term of the loan.
Keep in mind that many lenders require you to pay into an escrow account for your PMI (mortgage insurance), homeowners insurance, and property taxes. Therefore even though your mortgage may stay the same, your homeowner’s insurance and property taxes could increase or decrease over time.
What are the advantages of a fixed-rate home loan?
The main advantage is that your rate is fixed for the life of the loan. You won’t have to worry about your mortgage increasing. However, as stated above your monthly escrow (which includes your homeowner’s insurance and property taxes) could increase or decrease over time, which changes your total mortgage payment.
Another advantage to your rate is fixed for the life of the loan; it allows you to plan your budget for the future so you don’t have to worry about your rates shooting up if the economy is strong. No need to worry about your mortgage jumping from $1,500 per month to $2,000 per month.
Over time it’s assumed that your salary should increase and inflation will increase so your fixed-rate mortgage will be easier to pay. $1,500 now per month will worthless 10, 15, 20 years from now. The buying power of $1,500 will be less.
What are the disadvantages of a fixed-rate home loan?
The disadvantage with a fixed rate home loan is that the interest rates are normally higher than a variable rate mortgage. The security of a fixed-rate mortgage comes with a price. Also, over time your fixed rate may be higher than the market rate.
However, this may not be a problem if it makes sense to refinance your loan. If you plan not to live in your home long-term (less than 5 years) a fixed loan may not be right for you. You may be able to get an adjustable rate that is less and the interest rate locked for 5 years.
But keep in mind that your situation or the economy could change in 5 years. You may change your mind and not sell your home or the housing market may tank making it difficult to sell your home.
Who should get a fixed-rate home loan?
You should consider getting a fixed rate home loan if you have a tight budget and/or life of a fixed income. Also, if you want peace of mind knowing that your monthly mortgage will be the same every month; a fixed rate home loan is the way to go.
If you are still uncertain which loan is right for you, consult with a financial advisor. They can look at your current salary, debt, cost of the house, how long you plan to live in the home, and other factors to determine the best options for you.
Adjustable-Rate Mortgage
What is an adjustable-rate home (ARM) loan?
An adjustable-rate mortgage loan has an interest rate that adjusts periodically, usually every 6 or 12 months. The loan will adjust based on market interest rate movements.
What is a Hybrid ARM or Fixed-Period ARM?
Many lenders offer a “hybrid ARM”, also known as a “fixed-period ARM” which has an initial fixed period of 1, 3, 5, 7, or 10 years that adjust after the fixed period ends. Fixed period ARMs are usually named by the length of time the interest rate remains fixed.
A 3/1 ARM means that the loan is fixed for a 3-year introductory period, during which the interest rate remains fixed. The 1 means the interest rate will adjust once per year after the introductory period ends.
What are the advantages of ARMs?
The main advantage of an ARM is that the introductory period rates are lower than fixed-rate loans, which means your mortgage rate is lower. This can allow buyers to afford a more expensive home or lower their mortgage payments. There can be a difference of several hundred dollars per month which may appeal to some consumers.
What are the disadvantages of ARMs?
The main problem with ARMs is that when the introductory period ends, your rate will go up or down depending on market interest rates. You could potentially see your mortgage shoot way up. On the flip side, it would decrease. However, if you plan to live in your home for many years, is this a risk worth taking?
When considering an ARM, you should carefully consider your ability to handle a potentially sudden spike in your monthly mortgage payments.
What are ARM caps?
If you are considering an ARM, you should consider ARMs with caps to limit how much your rate can go up or down in a single adjustment period.
This limits how much your loan payment can change when it adjusts. Lifetime caps have a maximum interest rate over the entire life of a loan. It is important that you find to know the caps if you’re considering an ARM so you can then determine if you can handle rate increases.
Interest-only mortgage payment options can be available on ARMs or fixed-rate loans. During the I-O period, borrowers can delay making principal payments and make monthly payments that include only the loan’s interest.
After the interest-only period ends, however, if interest-only payments were made (you can choose to make regular principal + interest payments during the I-O period) your monthly payments will significantly increase when your required monthly payments start to include principal, plus interest.
Adding any unpaid principal from the first 10 years to the principal due on the remaining years of the loan plus interest due on the remaining portion of the loan can result in what is commonly referred to as “payment shock.”
You should carefully consider payment shock when considering an I-O payment option. Interest-only mortgages start with monthly payments that include only the loan’s interest.
After this initial interest-only period ends, however, the monthly payments can significantly increase when these payments then start to include the principal. This is called amortization. When an interest-only loan starts amortizing, the monthly payment amount increases, as you begin repaying principal in addition to interest.
What are the advantages of interest-only mortgages?
You can use an interest-only loan to purchase an expensive home with a much smaller monthly payment than if you had a conventional loan. This frees up money that you may want to put to better use.
If your income varies because your work is commission-based, an interest-only loan may make sense because it keeps your monthly payments small and when you are paid, you can then make larger payments against your principal.
Interest-only loans are used by speculative real estate investors who are betting that the value of the home will rise substantially offsetting the cost of having the loan. They plan on selling the home in a few short years with a profit, even though the balance of the loan hasn’t changed.
What are the disadvantages of interest-only mortgages?
The main disadvantage of interest-only mortgages is that you will build no equity in your home, thus you are not building wealth. Since you have no equity, you will not be able to borrow later with a second mortgage. If your home loses value, you more than likely will have to pay to sell your home.
With an interest-only mortgage, you are basically servicing a debt because you don’t reduce the balance of your loan. Keep in mind that at some point you will have to pay the money back. Your bank may ask that you pay back the principal after 10 years or so, which you should be aware of upfront.
You will eventually end up selling the home or refinancing the mortgage to pay off your interest-only loan. But keep in mind, in the long run, this could cost you dearly. For example, let’s say you purchased a $200,000 home with 20% down ($40,000), so your borrowed $160,000.
Over several years you make interest-only payments, but the home loses value and is now worth $130,000. You decide to sell, but you will only get back $10,000 (not excluding fees). You lost a whopping $30,000. If the value of your home falls below $120,000, you will have to pay at closing.
FHA Mortgages
FHA mortgage loans are fixed-rate mortgages backed by the government agency Federal Housing Administration (FHA). This guarantees that lenders will not have to write off the loan if the borrower defaults because the government will pay for the loss.
FHA loans may be a good option for some first-time buyers because there are no income limits. There is a limit to how much you can borrow and you are limited to smaller mortgage loans relative to home prices in your area. You can find the limits in your area by visiting HUD.gov.
How do I qualify?
To qualify for an FHA loan, you need to have decent credit and a reasonable debt to income ratio which will allow lenders to determine how much you can borrow.
What are the advantages of an FHA Loan?
The main advantage of FHA loans is that it allows lenders to offer lower down payment options as low as 3.5. FHA loan makes it easier for gifts to be used as down payments and closing costs. There is no prepayment penalty (an advantage for subprime borrowers).
FHA loans may be assumable; meaning someone else can take over your loan instead of having to refinance the home. FHA loans may offer some leniency during financially hard times. Finally, with FHA loans you use it for home improvements via FHA 203k programs
What are the disadvantages of an FHA Loan?
Since FHA loans are backed by the government if you default, there is an upfront mortgage insurance premium (MIP) of 1% which costs more than private mortgage insurance. With MIP you will also have to pay a modest ongoing fee with each monthly payment. Finally, if you need a large mortgage, then an FHA loan isn’t for you.
Keep in mind that if you have good credit, you may be able to find competitive rates that beat FHA loans.
Reverse Mortgages
Reverse mortgages allow qualified homeowners over the age of 62 to borrow equity from their homes. Instead of making payments to their lenders, lenders make payments to the homeowners (borrowers). Payments can be made as a lump sum, monthly, periodic advances via line of credit, and any combination.
Do I qualify for a reverse mortgage?
You must be over the age of 62 with a home and there must be adequate equity in the home. The existing mortgages must be paid off and differed maintenance and repair will be required, if necessary. Your FICO score and credit history are not required.
What are the fees to do a reverse mortgage?
Just like any other loan, there are fees. The fees can be rolled into the loan and financed. The fees will vary depending on your lender, your type of loan, and third-party vendors. Fees include:
- Normal closing costs
- Loan points or application fees
- Monthly lender fees
- Mortgage insurance premiums
How much can I borrow?
Your loan amount will depend on the type of loan you select, your age, and the amount of equity in your home after paying off an existing mortgage. Wells Fargo has an online reverse mortgage calculator you can use to determine how much money you can borrow.
What are the advantages of a reverse mortgage?
- Well, the first advantage is that you receive money to live on especially if you are in a financial crunch.
- The money is tax-free because you have to pay it back when you sell your home, you move out of the home or you die.
- Depending on your lender, normally there are no financial restrictions.
- Your FICO score or credit history plays no role in a reverse mortgage.
What are the disadvantages of a reverse mortgage?
- With reverse mortgages, there can be substantial fees. There may be upfront fees as high as $5,000 so it’s smart to shop around.
- Your payment amount may not be high enough to meet your financial needs.
- Your ability to get government assistance such as Social Security Insurance and Medicaid may be affected.
- If you die and full repayment isn’t made, the lender will take your home.
What are the different types of reverse mortgages?
There are 3 basic types of mortgage which include:
- Single Purpose Reverse Mortgage offered by state and local government agencies and some non-profit organizations. These organizations normally don’t have high fees associated with reverse mortgages. Availability of these loans are depended on where you reside and there are numerous regulations specified by the lenders regarding what you use the loan proceeds for. Also, there are income restrictions.
- Home Equity Conversion Mortgages are also known as HECMs are federally insured reverse mortgages that generally have higher upfront fees than a Single Purpose Reverse Mortgage. HECMs are widely available, do not have income requirements or purpose limitations. HECMs are backed by HUD so you are required to meet with a counselor from a housing counseling agency to explain the details regarding the loan.
- Proprietary Reverse mortgages are backed by private loan companies with options that will vary. These types of loans normally have higher fees than a HECM or Single Purpose Reverse Mortgage.
Where can I find reverse mortgage lenders?
You can visit The National Reserve Mortgage Lenders Association which publishes a list, sorted by state, of approved lenders who originate reverse mortgages.
You can also visit the Department of Housing and Urban Development which publishes a list of approved HUD lenders. You will have to check the box that limits the search to lenders who have completed a HECM loan within the past 12 months.
Home Equity Loans
A home equity loan allows you the homeowner to borrow money by using your home as collateral. If you don’t have good credit and want to borrow a large sum of money a home equity loan may be attractive to you. A home equity loan is a type of second mortgage and shouldn’t be confused with a home equity line of credit.
Lenders of home equity loans view these loans as safer because if you don’t pay, they will get your home. If you default on your loan, you can’t take the home or hide it. Additionally, most people don’t want to lose their homes, so they will make it a priority to pay.
Many home equity loan borrowers use the money to consolidate high-interest loans, remodel or renovate their home, pay for college education, or use it as a down payment for a second home.
What are the advantages of a home equity loan?
Home equity loans are normally attractive to borrowers because:
- Lower interest rates when compared to other loans.
- Easier to qualify for even if you have a poor credit history.
- Payments for home equity loans may be tax-deductible.
- Access to relatively large loans (depends on the equity in-home).
What are the disadvantages of a home equity loan?
- The main disadvantage is that you can lose your home if you default on your loan.
- Scammers may trap you with paying high fees or taking your home.
How do I find the best home equity loan?
You can save hundreds or even thousands of dollars with the best home equity loan. It’s best that you shop around via a variety of sources (brokers, credit unions, and banks). Ensure your credit report is accurate and manage your credit score. Ask around with your co-workers, family, and friends. Compare prices.
To limit your liability if you run into problems paying back the loan, consider purchasing an insurance polity to cover payments. If you do buy insurance, make sure to pay monthly premiums and not upfront if you decide to cancel.
HELOC Loans
A Home Equity Line of Credit (HELOC), a type of second mortgage, is a line of credit extended to homeowners who use their home as collateral. The line of credit is based on home equity. The homeowner may draw on the line of credit when funds are needed.
However, there is a specific period, known as the draw period, where the borrower is able to make withdrawals. There is a repayment period where the borrower must repay all funds that were withdrawn from the account during the draw period.
How is a HELOC different from a Home Equity Loan?
The difference is quite simple; while both loans are secured based on the existing home equity, the distribution of funds to the homeowner is different. With a home equity loan, the homeowner is given all the funds immediately, however, with a HELOC, the funds are not immediately withdrawn by the homeowner.
The homeowner withdraws funds as needed. There are restrictions as to how much and when funds can be withdrawn.
What are HELOC loans typically used for?
While other loans, such as a traditional mortgage or car loan, must be used for specific purposes, a HELOC can be used for anything specified by the homeowner. Many homeowners use HELOC loans for home renovations, starting a small business, taking a dream vacation, paying for college, etc.
Interest paid on a HELOC loan in some cases may be tax deductible if the funds are used to make repairs or improvements to a home. Consult with your tax professional to determine if you qualify for a tax deduction.
What are the advantages of a HELOC?
The advantages of a HELOC are as follows:
- No closing cost – If your credit is good, you will pay no closing costs.
- Low-interest rate – HELOC interest rates is variable and based on the prime rate, which is relatively low when compared to standard interest rates. If you can take a tax deduction on the interest, then the interest rate is even lower.
- Interest rate caps – If the prime rate increases, your HELOC interest rate should have a cap on how high it can increase on a quarterly basis. Most HELOC loans will increase by a half percentage point.
- Pay it off anytime – Most HELOC loans allow you to pay off the balance at any time with no fees. Before you signup for a HELOC loan make sure this is the case.
- Convert to a fixed-rate loan – If your HELOC interest rate jumps and a fixed-rate home equity loan is more attractive, you should be able to convert whenever you like. Again, before you signup for a HELOC loan make sure this is the case.
What are the disadvantages of a HELOC?
The disadvantages of a HELOC are as follows:
- Adjustable interest rates – All HELOC loans are adjustable rates and have a higher risk than ARMs. Some HELOC loans do not have a guaranteed initial interest rate like an ARM that may have a fixed rate of up to 10 years.
- Caps on interest rate – HELOC loans don’t have the same type of adjustment caps as ARM (Adjustable Rate Mortgage) loans. As a result, HELOC interest rates rise quickly. ARMs usually have lower maximum rates than HELOC loans. ARMs usually have a max rate of 5-6% higher than the initial rate; however, HELOC could have as high as 18%.