Step 3: Learn About Home Loans

Now that you have reviewed your credit and learned about the money you'll need to buy your home, the next step is learning about mortgages. Which mortgage you choose depends on many factors, including how much money you have for a down payment, how long you plan to live in your home, and your financial future.

The mortgage lending business is competitive, and you'll see many advertised offers that look appealing. Sorting through the offers can be a bit confusing and it's important to look beyond the advertised offers to learn the details. By learning the basics you will know the questions to ask, be able to compare mortgage options, and ultimately choose the mortgage that's right for you.

What Is Included in Your Monthly Mortgage Payment?
Most monthly mortgage payments include the following costs, often abbreviated as PITI:

• Principal: The part of your payment used to pay back your original loan amount
• Interest: The part of your payment used to pay the interest on your mortgage loan
• Taxes: The part of your payment used to pay the real estate taxes collected by your local government
• Insurance: The part of your payment used to pay the premium for homeowner's insurance
  

In addition, some mortgage loan payments may include private mortgage insurance.

Mortgage Loan Options
The most common mortgage loan options fall into three major categories: fixed-rate mortgages, adjustable-rate mortgages (ARMs), and balloon mortgages.

Fixed-Rate Mortgage
A fixed-rate mortgage guarantees that your interest rate will remain the same, or fixed, as long as you have your loan. This mortgage type may be right for you if you plan to live in your home for a long time and you like the security of a fixed interest and principal payments. It is important to note that although your principal and interest payments remain fixed, your real estate taxes and insurance premiums may increase. In that case, it is likely that your overall monthly payment will also increase.

The most common terms for a fixed-rate mortgage are 30, 20, and 15 years. Typically, the longer the term (30-year vs. 15-year), the more interest you'll pay over the life of the loan. Shorter-term loans enable you to pay less in overall interest and build equity faster than longer-term loans, but your monthly mortgage payments will be higher.

Adjustable Rate Mortgages (ARMs)
An adjustable rate mortgage (ARM) has an interest rate that can go up or down as market conditions change. Depending on market conditions, ARMs may offer a lower interest rate than fixed-rate mortgages (for a certain period of time), and this may help you qualify for a larger loan. Keep in mind that after a defined period (usually anywhere from three to 10 years), your monthly payments may increase if interest rates increase. An ARM might be a good choice if just are starting out in your job and expect your income to increase, or if you plan to refinance or sell your home within a few years of purchase.

The interest rate on an ARM is based on an index (e.g. tied to the U.S. Treasury securities). There are various ARM products available, with different adjustment periods (the rate your loan will change at scheduled times). The most common types of fixed-period loans include 3/1, 5/1, 7/1 and 10/1 ARMs. This type of ARM maintains the same initial interest rate for the first three, five, seven, or ten years of the loan. For example, the interest rate on a 5/1 ARM will not change for the first five years, but can change in its sixth year, and every year after that.

Interest rate changes are typically are subject to two caps (limits), one for each adjustment period and one for the life of the loan. For example, a typical ARM that adjusts annually may have a per adjustment cap of 2 percentage points and a lifetime cap of 6 percentage points.

To help you compare loan offers and plan for rate changes, ask your lender these questions:

• What index is my ARM loan tied to?
• What is your margin on the index?
• When are the scheduled adjustment periods?
• What is the periodic cap?
• What is the overall cap?
  

Balloon Mortgage
A balloon mortgage is a short-term, low interest loan. It is called a balloon mortgage because at the end of the term, the entire loan amount is due. The term varies, but often is five or seven years. At the end of this term you have the option to refinance the mortgage for the remaining amount or pay off the outstanding balance with a lump-sum payment. If you anticipate selling or refinancing your home in a few years, a balloon mortgage may be right for you. However, be sure to ask your lender about all the conditions you will need to meet to refinance your loan at the end of the balloon term.

There are also Government Loan programs. The Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA) are two federal agencies that offer government-insured loans. To obtain these loans, you apply through a lender that is approved to handle them. These loans require the property being purchased to meet certain minimum standards. To qualify for a VA loan you must have had military service. Talk to your lender to find out more about these loan programs.

Continue to Page 2: How to Compare Loans