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Sorting Through Home-Loan Optionsby Tony HernandezSo you've finally found the perfect house for your family. The seller has agreed to a reasonable price for this, your two-story, white-picket-fenced home, and it's time to finance. Sitting down with your loan officer, you're hit with mortgage offers that go beyond dad's good ol' fixed-rate mortgage. You're presented with attractive lingo you vaguely understand, like adjustable rate mortgages and interest-only mortgages. What's it all mean? What's the best choice for you? Your decision will affect your finances for years to come. The last thing you want is confusion. With today's housing market continuing its explosive boom in the Rock River Valley and across the country, the time is right to explain how all of this financing works. Getting down to business Before that first conversation with a loan officer, it's beneficial to have a full understanding of your financial situation, experts say. "The best advice that I can give is if a person is unbudgeted, now is the time to create a household budget so that they do have that awareness of income, expenses and total debt that they owe," said Heidi Berardi, director of education and community outreach at Family Credit Counseling Service in Rockford. Berardi said that it's important to know your current debt because a future house payment will become the biggest responsibility in the budget. Mortgage consultants like Melissa Williams, who works for Wyndham Capital Mortgage, an online company that does business in Rockford, tend to agree. One of the key factors lenders use to determine a loan approval is a ratio of debt to income. Williams said that knowing all your assets -- checking, savings, 401(k), certificates of deposit, and so forth, will help you determine how much money you'll have for a down payment. Rockford native Shirley King is no stranger to the mortgage process, having recently closed on her third home loan. A business owner in Maryland, King recently bought a second home in Rockford for her sister. The spacious house will be a place to stay when King returns to visit family. King suggested first-time home buyers who may be unsure of what assets are best to use for a down payment talk to their real estate agents, who "will look at your finances and tell you what you can afford." They also could possibly recommend mortgage companies and offer advice on what programs may be best for you. Williams said a real estate agent will help in figuring out property taxes associated with the home. Knowing the property taxes will also help determine whether you can afford the home. "If you're going to get into a situation where you think you're going to get a good deal on a house but the taxes are high, it may prevent you from being approved for the loan because that's going to go into figuring your debt-to-income ratio," Williams said. It's also important for a potential home buyer to realize that the cost of a home goes beyond a monthly payment. "A house payment should not exceed 25 (percent) to 30 percent of a consumer's gross income," Berardi said. "If a person exceeds that amount, that's where they can really get into trouble. The cost of a house includes property taxes, homeowners insurance, any type of decorating and then of course just home repair. If the roof goes out, that's a responsibility that homeowner has to take on. A lot of people have put themselves in precarious positions without planning for those types of expenses in their budget." So, if a person already has a lot of debt, Berardi suggests not buying a house until the debt has been reduced so the finances are available to handle the costs associated with keeping a house. We'll tell you about the three most common financing tools when it comes to home buying. But remember, fixed-rate mortgages, adjustable-rate mortgages and interest-only loans are just the beginning. Families with lower income, for example, could qualify for loans through the Federal Housing Administration. Military veterans can get excellent loans through the Department of Veterans Affairs. And lenders have a variety of loan products that might work better for you than the three plans we're about to explore. Figuring out what works best requires lengthy conversations with financial professionals, whether loan officers, real estate people or credit counselors. "As in doing any kind of business deal, always make sure you get the terms in writing," Berardi said. "And if you don't understand it, have someone you trust to be able to review that for you." Tried and true: The fixed-rate mortgage A fixed-rate mortgage is probably the easiest loan product to understand. It does not change its interest rate or monthly payment throughout the life of the loan. The term of the loan could vary, though the two most popular are for 15 and 30 years. These types of loans were around years before other loan products were developed, and experts continue to say they still are the way to go for most consumers. "The ideal loan for me would be a 15-year, fixed-rate mortgage, because with that mortgage the payment is going to be a little bit higher," Berardi said. "If somebody can afford it, they can actually pay the loan twice as quickly as the 30-year loan." Generally speaking, you get a lower interest rate on the 15-year fixed as opposed to the 30-year, but the difference varies by broker, Berardi said. "But usually, I'd say, if someone is in good financial condition, a 15-year fixed is going to be a good choice as far as saving on interest in the long run. But the 30-year fixed is a good option for someone who is looking to stay in their home and just have a little bit of a lower payment. Wyndham Capital Mortgages Williams said the 30-year fixed can give consumers an option in payments. Right now, the 30-year rates are very competitive, she said. The difference in rates right now from a 30- to a 20- to a 15-year is not much. Williams said that if you go with the lower payment of the 30-year fixed, you will have the option of paying the higher 15-year payment, thus reducing the principal of the loan faster. So if you have a bad month or a couple of bad months, then you can back off and make the 30-year payments, she said. She added, One of the drawbacks to a 30-year fixed is that the payments are not going to be as low as they would be on say an ARM product. The ARM: Adjustable-rate mortgage Cant qualify for a fixed rate? Try an adjustable-rate mortgage but be careful. These products have two stages: The first is similar to the fixed-rate mortgage, only this time the rate stays fixed just for a limited time. Most ARMs, as adjustable-rate mortgages are known, will have the initial fixed-rate period for three, five, seven or 10 years. In most cases, the lower the interest rate on an ARM, the shorter the fixed-rate period. Once the initial fixed-rate period is over, the interest will more than likely go up, though it is limited through caps set by the lender. Figuring out the increase in rates requires two pieces of information: First, the index. Rates on ARMs are based on indexes that can be found in most newspapers or on the Internet. Secondly, lenders will also set a margin that will be specified in the contract (usually 2.5 percent to 3 percent). Add the current value of the rate, based on the appropriate index, plus the margin, and you get the new rate. This may be the most important fact: The new, higher rate will mean an increase in your monthly payment. With the ARM loans, those are more ideal for people who do not feel like theyre going to be in a situation for a long time, maybe three or four years, Berardi said. Then perhaps theyre going to move on. Thats precisely what King, the Maryland businesswoman who just bought a house in Rockford, has planned for herself. She has a five-year ARM for her home in Maryland. Im a bit of a risk-taker, and from that perspective, I chose the ARM, King said. It gives me more house. My goal is to retire in the next five years. And I may move back to Rockford or move south to North Carolina. Whereever she chooses, King will have established equity on the house and saved money based on the lower ARM interest rate. Interest-only loans Among some financial experts, interest-only loans are known as risky mortgages. The reality is that these types of loans could fit nicely to the lifestyles of certain people. Interest-only loans can feature either an adjustable- or fixed-rate mortgage, but Williams said most lenders give the interest-only option only on ARMs. If a consumer chooses the interest-only plan, an initial payment period (usually from five to 10 years) will require the borrower to only pay the interest of the loan. If the consumer only pays interest, of course, there will be no reduction of the principal, or balance, of the loan. Therefore, monthly payments on interest-only loans are lower than those of the other loan products. This makes it easier for a consumer to qualify for a home that otherwise may not be affordable. But heres the rub: Once the interest-only period is over, payments will increase significantly. Whenever I talk to a person and theyre asking me about an interest-only, I get to the heart of why theyre doing an interest-only, Williams said. The negative of the interest-only is that now, people who cant necessarily afford a house are using the interest-only ... and then theyre never building any equity in that house. So then you start hearing ugly words like negative amortization, which means theyre actually increasing the outstanding amount they owe on their house rather than decreasing it over time. So what are the ideal conditions for taking out an interest-only loan? The reason that an interest-only would be a good loan product for you is if you know your house is going to appraise up or increase in value, Williams said. Even though youre not making payments toward your principal, youre still building equity because your house is increasing in value. Another reason why people use interest-only products, Williams continued, is if they are very investor-savvy, and they want the liquidity of their money. So rather than tying up their cash in the house, they want to use it to invest in stocks or invest in other real estate. Berardi says that most loan officers should help you determine whether an interest-only product could properly benefit you. A lot of mortgage professionals really do have the best interest of the consumer in mind, she said. They dont want to get them into a product that is going to cause them to fail. Article Reprinted Courtesy of The Rockford Register Star 
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