The recent mortgage meltdown should have driven home the lesson that understanding one’s home loan is critically important. However, most people fail to think about mortgages because they find the topic too complex. In fact, a survey by Zillow Mortgage Marketplace found that borrowers who obtained a home loan in the past five years typically spent just five hours researching their options — that’s half the amount of time people spend researching a car purchase (10 hours). Nearly one-third spent two hours or less. Yet, a home purchase is one of the largest investments most people will make in their lifetime, and the type and terms of their loan greatly affects affordability. That’s why before choosing a home loan, borrowers should shop and compare mortgage rates as well as mortgage lenders and once they’ve chosen a loan, make sure they understand these five home loan basics:
1. Do you have a fixed-rate mortgage? You might be surprised to find out how many people think they have a fixed-rate mortgage only to learn later that they don’t. There’s an easy way to find out what kind of rate you have (depending on how organized your files are). Find the packet of papers that you signed at the title company when you closed on your house and there should be a document titled “NOTE” at the top. If it says “ADJUSTABLE RATE NOTE” at the top in big capital letters, then you obviously don’t have a fixed-rate loan.
Why it matters: While adjustable-rate mortgages often feature lower rates early in the loan term, your rate and payments can rise significantly over the life of the loan. With a fixed-rate mortgage, your rate and payments remain constant. This is obviously an important distinction from a budgeting and financial planning perspective. Learn the differences between ARMs and fixed-rate mortgages.
2. If you have an ARM (Adjustable Rate Mortgage), when does the rate adjust, and how far up and down can it go?
There are many types of ARMs available, so it’s important to know the terms of your specific loan. What you need to know is when can your rate adjust, how far up go up or down can it go, and how often? Once again, look at your note to find out the terms of your ARM. A common adjustment schedule might be 2/2/5, meaning the rate won’t adjust for two years after you got your loan, it can go up or down a maximum of 2 percent a year, and caps out at a maximum of 5 percent higher than your initial rate.
Why it matters: Knowing the details and financial implications of your ARM will help you avoid any surprises. Get a reality check and ask your lender about the worst-case scenario you could face when the rate resets so you can plan accordingly.
3. Do you have mortgage insurance? If you purchased your home with conventional financing and your down payment was less than 20 percent, you are most likely paying for private mortgage insurance. Typically, mortgage insurance costs the borrower between $25-$100 a month. However, once you have sufficient equity in your home (20 percent) you may no longer need mortgage insurance. If this is the case, call your lender to discuss how you can go about canceling it. Most commonly lenders will require a full appraisal to be done — but each lender has slightly different requirements when it comes to canceling mortgage insurance, so be sure to call your lender for more information.
Why it matters: Canceling mortgage insurance, once you no longer need it, could save you money each month.
4. Do you understand all of your loan options? If you haven’t gotten a loan yet, do you know and understand the different options that are available to you? Should you get an FHA, VA, USDA or conventional loan? There are pros and cons to each of these loan programs and having a loan officer make a recommendation is just that, a recommendation. Be sure to research and compare various mortgage rates and loan programs so you can choose the best loan for you and your personal situation.
Why it matters: You can save thousands of dollars over the life of the loan by doing a little competitive mortgage shopping. A site like Zillow Mortgage Marketplace enables you to quickly submit a loan request — without sharing any personal information — and easily compare mortgage rates and loan programs from hundreds of vetted lenders nationwide so you can choose the loan that best fits your financial situation.
5. Does your loan have a prepayment penalty? If a borrower pays off the loan earlier than was originally intended, a prepayment penalty may be assessed. Normally, prepayment penalties are only charged if the borrower sells or refinances his home in the first few years of the mortgage. FHA, VA and USDA loans never have a prepayment penalty. If you are considering getting a mortgage with a prepayment penalty, be sure to consider how long you expect to stay in your home and understand the pros and cons of accepting such a penalty, and what your options look like without accepting it.
Why it matters: Loans with prepayment penalties usually have lower interest rates than loans without prepayment penalties. You want to make sure the savings from the lower interest rate is sufficient to cover the cost of the prepayment penalty should you chose to sell or refinance before the penalty expires.
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