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What exactly is a mortgage? Simply put,
it's a loan from a financial institution
to you. In return, you pay interest on
the amount loaned. The lender also has
first dibs on your house in case you
neglect to pay back the loan.
Francophiles and wordsmiths will
recognize the root word "mort"
in there. No, that's not your Uncle
Mort; that's the French word for
"dead." The idea is that
you're going to kill off that loan, by
paying back the money you borrowed. You
amortize the loan, over time. Yes, it's
a slow death, but it must be carried
out.
A loan has three facets:
- size (how many
dollars you need to borrow)
- interest (the
percentage rate you pay on the loan)
- term (how long it
will take to pay off the loan)
The first one is self-explanatory
(although there are choices you can make
with regard to the down payment, which
we'll investigate in a little while).
The other two are more complicated.
Let's look first at the interest rate.
The Calculation of APR (Annual
Percentage Rate)
The annual percentage rate is a
method developed under federal law to
disclose to loan applicants the actual
amount of interest that will be paid on
a given loan, over the life of that
loan. It makes it easy to compare one
mortgage to another by making it an
apples-to-apples comparison. You should,
however, use the APR as just one tool in
evaluating a loan, not as the sole
factor in making your decision.
To understand APR, you must first
understand the concept of points. A
point is 1% of the loan amount. If the
loan is for $100,000, one point is
$1,000.
There are two types of points:
origination and discount. Origination
points are the fees normally charged
by a lender, and sometimes by a mortgage
broker, for originating, or starting up,
your loan. Discount points are charged
to lower your interest rate, and this
lowers your payments. In other words, if
you pay some more money up front, the
bank will let you pay less over time.
Both types of points should be
considered interest that you pay up
front. Therefore, you must figure points
into the cost of your loan repayment. If
you take out a loan for $120,000 at 9%
interest for 30 years, and you pay one
origination point and one discount
point, you're paying a total of two
points, or $2,400. Your payment will be
$965.55 per month.
To get the proper APR on your loan,
then, you have to add that $2,400 to
your starting balance, since (remember?)
it is interest, albeit prepaid interest.
This makes your total loan $122,400.
Figure the new payment on that balance,
which works out to $984.00. Now return
to the original loan amount and (ready,
mathematicians?) compute the polynomial
backwards to reach the interest rate it
would take to equal the payment on the
total loan. It works out to roughly
9.23%.
In paying points to lower your rate,
a good rule of thumb is that it will
take you about five years to make up the
additional point(s) paid; then you will
begin saving money over the remaining
term of the loan.
By federal law, lenders are required
to send you a TIL (no, that's not
something you get your hand caught in
when you're stealing -- it stands for
Truth in Lending) statement within three
days of applying for a loan.
The Term
The most common term for a fixed-rate
mortgage is 30 years, with 15 years the
next most common.
A 30-year vs. 15-year mortgage debate
rages, but one thing is sure: You will
pay much more interest over the term of
the loan (in most cases double) on a
30-year mortgage. On the flip side, a
30-year mortgage will offer lower
monthly payments. You'll be getting a
tax write-off for the interest portion
of your payments, which could be
substantial. On the other hand, in the
first 15 years of your loan, you will be
unFoolishly lining someone else's pocket
with interest, while not building up
significant principal for yourself.
Example: Let's say you buy a $150,000
home. You put down 20%, or $30,000,
which leaves you $120,000 to finance. If
you get a 30-year loan at 8.5%, your
payments are $922.70. After five years
of payments, your balance owed is
$114,588. If, on the other hand, you
obtain a 15-year mortgage at 8.00%
(rates are lower with shorter-term
loans), your payments are $1,146.00
($224.00 more each month). After five
years in this loan, however, your
balance is only $94,000. That's quite a
difference when it comes time to sell.
In sum, a 30-year loan is good for
long-term stability. If you can afford a
15-year mortgage, you will build
principal faster. Another option would
be to pay what would be equal to the
15-year payment on a 30-year loan,
enabling you to pay it off in about 15
years (slightly longer due to the higher
interest rate), while still having the
cushion of the lower payment should
money problems arise.
Details...
There's one other loan categorization
that has to do with size. A conforming
loan is less than the Federal
National Mortgage Association's
legislated mortgage amount limit, which
is currently $322,700 for a
single-family home. A jumbo loan, also
known as a nonconforming loan, exceeds
that amount. Since such jumbo loans
cannot be funded by the agency, they
usually carry a higher interest rate.
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