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Mortgage 101

For most people, a financing solution is necessary for making the dream of homeownership a reality. The standard solution for home financing is called a mortgage, which allows individuals to purchase real estate without the need to pay the full value immediately, using the home and property it sits on as collateral. Securing a mortgage might seem to be daunting task, but it's relatively simple if you go into the process prepared.

Once you've determined that you're in a financial position to purchase a home, you'll need to familiarize yourself with the basics of the mortgage process. We've assembled some information in this section to help give you some background on mortgages, their various types, how they work, and some of the associated terminology as well as links to resources that can provide you with assistance.

Also, be sure to make use of the REALESTATELOUISIANA.com mortgage calculators as you determine what type of mortgage may be best for you.

ABOUT INTEREST RATES

Research interest rates
Start the process of shopping for a mortgage by looking at current interest rates and rate activity. Mortgage rates usually reflect what is happening with interest rates, as well as the stock market. Stay tuned in to what is going on with interest rates and other economic trends so you will be prepared to take advantage of good mortgage rates. Use the advertised APR (Annual Percentage Rate) to compare mortgage companies and rates.

Pre-Qualifying
It's usually a good idea to meet with your bank or mortgage company before starting your home search and "pre-qualify" for a mortgage loan so that you know in advance how much you can afford, and the mortgage amount you'll have to work with. After meeting with a lender, filling out an application and providing the needed financial information, they can let you know how much you have qualified for within a few days.

What are Points?
Points are fees that the borrower pays the lender at the time the loan is closed, expressed as a percent of the loan. For example, on a $100,000 loan, 3 points means a payment of $3,000. Buying mortgage points when you close your mortgage can reduce its interest rate - which in turn reduces your monthly payment - but each point costs you 1% of your mortgage balance.

Lock in That Rate!
Once you have identified a lender offering a good rate that you want to work with, you'll want to lock that rate in. A lock-in or rate commitment is the lender's promise that they will hold a certain interest rate and a certain number of points for you, for a specified period of time while the loan application is being processed. You'll either be able to lock in the rate and number of points when you file the application, during processing, or after loan approval, depending on the lender.

TYPES OF MORTGAGE LOANS

Selecting the right type of mortgage depends on several different factors, including your current financial picture, how long you intend to keep the house, whether you want an adjustable or fixed rate mortgage, and so on. Discuss your situation with a mortgage professional and consider all options in order to help find the "right" answer. To get you started, we've assembled some information on the more common types or loan products:

Conventional Loans and Jumbo Loans
Conventional loans are secured by government-sponsored entities such as Fannie Mae and Freddie Mac. These loans can be used to purchase or refinance homes with first and second mortgages on single family to four family homes.

The loan limit for conventional loans ($417,000 for single-family in 2006, Fannie Mae and Freddie Mac) is reviewed each year and adjusted if necessary to reflect changes in the corresponding national average sales price.

If you want to go the conventional loan route, but need a loan that exceeds the limit set by Fannie Mae and Freddie Mac, you will want to consider jumbo loans. Jumbo loans will carry a higher interest rate because they are not funded by government-sponsored entities.

FHA Loans
FHA's mortgage insurance programs are beneficial to low and moderate income families because they lower some of the costs of the mortgage loans. FHA loans are insured by the U.S. Department of Housing & Urban Development (HUD), so lenders are more willing to give loans with lower qualifying requirements so it's easier to qualify as opposed to a conventional loan. FHA loans require a low (3%) downpayment and have very competitive interest rates. Should you encounter hard times after buying your home, FHA has many options to help keep you in your home and avoid foreclosure. More information on FHA programs is available from the HUD website.

VA Loans
If you are a veteran who served on active duty and were discharged under conditions other than dishonorable, during World War II and later periods, you are eligible for VA loan benefits. Applicants will need to get a Certificate of Eligibility from the U.S. Department of Veterans Affairs (VA) to prove to the mortgage company that you are eligible for a VA loan. Aside from the certificate, the application process is not much different than that of other loans, and no down payment is required in most cases. Click here for complete information on the VA loan program.

Fixed Rate Mortgages (FRMs)
Fixed rate mortgages (FRMs) are the standard type of mortgage program most people are familiar with, where your interest rate remains fixed for the life of the loan and monthly payments for interest and principal never change. These loans are available for 30 years, 20 years, 15 years and 10 years, with 30- and 15-year mortgages being the most common.he most common fixed rate loans are 15 year and 30 year mortgages.

In fixed rate mortgages, a large percentage of the monthly payment is used for paying the interest during the early amortization period. As the loan is paid down, more of the monthly payment is applied to principal. A typical 30 year fixed rate mortgage takes 22.5 years of level payments to pay half of the original loan amount.

Adjustable Rate Mortgages (ARMs)
Adjustable rate mortgage loans (ARMs) start out with an introductory interest rate that could be as low as 5 percent below a comparable fixed rate mortgage. The interest rate then changes at specified intervals depending on current market conditions. For example, if interest rates go up, your monthly payment goes up. If interest rates drop, your mortgage payment goes down.

The advantage to ARMs is that the lower initial interest rate could allow you to buy a more expensive home. The disadvantage obviously is that after the introductory interest rate period is over, your monthly payments are dictated by market conditions. If you decide to choose an ARM, there are several types that you may want to discuss with your mortgage professional in order to find the best fit for your situation. These include:

6-Month Certificate of Deposit (CD) ARM
A maximum interest rate adjustment of 1% every six months. The 6-month Certificate of Deposit (CD) index is generally considered to react quickly to changes in the market.

1-Year Treasury Spot ARM
A maximum interest rate adjustment of 2% every 12 months. The 1-Year Treasury Spot index generally reacts more slowly than the CD index, but more quickly than the Treasury Average index.

6-Month Treasury Average ARM
A maximum interest rate adjustment of 1% every six months. The Treasury Average index generally reacts more slowly in fluctuating markets so adjustments in the ARM interest rate will lag behind some other market indicators.

12-Month Treasury Average ARM
A maximum interest rate adjustment of 2% every 12 months. The Treasury Average Index generally reacts more slowly in fluctuating markets so adjustments in the ARM interest rate will lag behind some other market indicators.

There are also some mortgages that combine aspects of both fixed rate mortgages and ARMs. These may maintain a low fixed rate for an extended period (7-10 years) and then adjust based on changing interest rates.

Balloon Mortgages
Balloon mortgages are short term loans that have some features of a fixed rate mortgage. The loans provide a level payment feature during the term of the loan, but as opposed to the 30 year fixed rate mortgage, balloon loans do not fully amortize. At the end of the loan term (usually 5-7 years for a first mortgage), the mortgage company usually requires that the remaining principal loan balance be paid in full (the balloon payment). This can be handled by refinancing, or converting to a different kind of loan at the end of the term if offered by your mortgage company. Balloon mortgage programs with a conversion option are often called a 7/23 Convertible or a 5/25 Convertible.

Reverse Mortgages
A reverse mortgage enables older homeowners (62+) to convert part of the equity in their homes into tax-free income without having to sell the home, give up title, or take on a new monthly mortgage payment. It's called "reverse" because the mortgage payment stream is “reversed.” Instead of making monthly payments to a lender, as with a regular mortgage, a lender makes payments to you. Eligible property types include single-family homes, manufactured homes (built after June 1976), qualified condominiums, and townhouses.

Funds received from a reverse mortgage can be used for anything. Common uses include supplementing retirement income to cover daily living expenses; repairing or modifying your home; covering health care expenses; paying off existing debts; etc. There are no income or medical requirements to qualify. You may be eligible for a reverse mortgage even if you still owe money on an existing mortgage. However, you must qualify for a large enough reverse mortgage to pay off the existing loan entirely.

No monthly payments are due on a reverse mortgage while it is outstanding. The loan is repaid when you cease to occupy your home as a principal residence, whether you (the last remaining spouse, in cases of couples) pass away, sell the home, or permanently move out. The amount owed can never exceed the value of your home. Furthermore, if the home is sold and the sales proceeds exceed the amount owed on the reverse mortgage, the excess money goes to you or your estate.

Buydown
This is a type of mortgage loan where the interest rate is reduced by paying more up-front at closing, and then the rate is increased by one percent each year for the "buydown" period. For example: For a 2-1 buydown at an 8% rate, Year 1 the rate is 6%, Year 2 the rate is 7%. For Year 3 through the life of the loan, the rate is 8%.

Qualification rules for the loan programs remain the same. Depending on the lender, the buyer may qualify using the reduced rate. (Example: For a 3-2-1 Buydown at a rate of 8%, the buyer could qualify using the 5% rate.)

The difference between the actual payment schedule and the rate schedule is usually paid "up-front" at closing. This can be paid by the seller, the buyer, the homebuilder, or in some cases, the lender. If the cost is borne by the lender, it is usually offset with increased rates or in points. Generally the funds used to buy down the loan are held in a separate account and are applied with the borrower's payment to equal the true interest rate.

Graduated Payment Mortgage (GPM)
A graduated payment mortgage (GPM) begins with small payments and gradually raises them (usually over a five to ten year period). The payments then remain fixed for the remainder of the loan. However, this is a negatively amortizing loan, which means that the difference between the interest paid and the interest due is deferred and added to the loan balances. Because of this, your loan amount will increase once you start paying off the loan; it will amortize normally at the end of the loan period.

GPMs are more popular when the interest rates are higher, providing a financial incentive for potential buyers. Since many lenders will qualify a buyer at a lower rate, a buyer can secure a larger mortgage. These loan types are advantageous for buyers who expect their incomes to increase to cover the increase in loan amount.

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