You found the perfect house; now what?

Castles in the Sand

You may think it’s finally over – you found your dream home, your forever home or your long-dreamed-of beach house. But guess what, unless you have lots of cash in your checking account, you will have to apply for a mortgage.

There have been for many, many years two basic types of mortgages, the fixed-rate mortgage and the adjustable-rate mortgage or ARM. The fixed-rate mortgage is just that – your principal and interest payment are fixed for the life of the mortgage or until you sell the property and satisfy the mortgage balance. Fixed-rate mortgages give you a set amount of money every month to budget for and builds equity for a home that you feel will be a long-term purchase. Building equity will also give you the option of refinancing in the future if rates go down possibly resulting in a lower monthly mortgage payment.

Adjustable-rate mortgages are typically a fixed rate for a specific number of years, for example, 5 years, and then are adjusted annually either up or down. Generally, adjustable-rate mortgages start at a lower rate than a fixed rate, but you take the risk of monthly payments increasing substantially as the rates fluctuate after the fixed number of years has been reached.

Adjustable-rate loans could be a good choice if you’re planning on selling your home within a short period of time prior to when the fixed-rate term expires. However, this type of mortgage does not build much, if any, equity, a consideration in a real estate market that may be on the way down.

Whichever type of mortgage you choose, the amount of money you put down will influence the rate you are offered. A 20% or higher down payment will likely provide the best mortgage rates and the most options as well as substantially reducing the risk of the home not appraising.

Putting down between 5% and 19% will put you in the position of having to pay a higher interest rate and/or fees. In addition, lenders most likely will require private mortgage insurance (PMI). Private mortgage insurance is an insurance policy that allows you to make a lower down payment by insuring the lender against loss if you don’t make your mortgage payments. A lower down payment could be a good thing for buyers with little cash or if the home requires work and the cash to do it. PMI payments start going down after equity has built up in the home.

Finally, there are no-down-payment or small-down-payment loan programs which are more expensive but are an alternative. If you or someone in your family are trying to get into a home with little cash, they should research FHA loans or, if qualified, VA loans, both with low down payment options.

Two things you should try and avoid in-home financing are balloon payments and prepayment penalties. Balloon payments are a large payment required usually at the end of the loan repayment period with varying amounts based on the terms of the loan. Prepayment penalties are an amount required if you refinance, pay off your loan early or sell your home. And one nice little trick to help you pay off your mortgage sooner and build equity is to make extra payments during the course of the year.

Once you find the perfect mortgage and get through the mortgage qualifying maze, you’re ready to enjoy your perfect home; I hope for you, it’s the beach house.

More Castles in the Sand:

Is homeownership threatened?

Real estate market disruption

Fee-fi-fo-fum, do I smell a recovery?