Choosing a Loan
Choosing a Loan
There are literally hundreds of lenders offering a multitude of loan options that makes determining the best loan for your situation a complex endeavor. Since you may be making payments on a loan anywhere from 15 years to 40 years depending on the term, it is imperative that you work closely with us in choosing the right lender and loan that works best for you. What follows is a breakdown of the generally available residential loan programs.
- Fixed-rate loans
This is a home loan with an ensured interest rate that will remain at a specific rate for the term of the loan. About 75 percent of all home mortgages have fixed rates. One reason for this is that most homes sold are to buyers who plan on living in their property for many years. When you choose the length of your repayment (usually 15, 20 or 30 years), keep in mind that while shorter term loans may have higher monthly payments, they also let you pay less interest and build equity faster.
- 30-year fixed-rate loan
The most popular loan is a 30-year fixed-rate loan. The reasons include:
- It provides the borrower with reasonable monthly payments.
- It’s ideal for the homebuyer who plans on remaining in the home for more than 5 years.
The 20-year mortgage often offers a lower interest rate when compared to a 30-year loan. This loan amortizes principal and interest over a 20-year period, 10 years less than the traditional 30-year mortgage. This may save you a considerable amount of total interest when paid over the life of the loan.
The advantage of a 15-year mortgage is that its interest rate is generally lower than a 30-year or 20-year loan. Such a short-term loan will save you a significant amount of interest over the life of the loan. By paying off the loan in only fifteen years, you also build up equity in your home sooner. A 15-year loan allows you to own your home clear of debt much quicker when compared to longer term loans. This may be important if you are approaching retirement or have other large expenses to cover such as financing your children’s education. However, the monthly payments you make on a 15-year loan will be significantly higher than those you make on a 30-year or a 20-year loan for the same loan amount.
With an adjustable-rate mortgage (ARM), the interest rate you pay is adjusted from time to time to keep it in line with changing market rates. This means that when interest rates go up, your monthly loan payment may go up as well. On the other hand, when interest rates go down, your monthly loan payment may also go down. ARMs are attractive because they may initially offer a lower interest rate than fixed-rate loans. Since the monthly payments on an ARM start out lower than those of a fixed-rate loan of the same amount, you should be able to qualify for a larger loan.
The chief drawback, of course, is that your monthly payment may increase when interest rates go up. The types of people who typically benefit from an ARM are those that are planning to move or refinance in the near future, people with a high likelihood of increasing their income in later years, and people who need lower initial interest rates on their loans to be able to buy a home. How much your payment can increase will depend on the terms of your loan.
Before applying for an ARM, be sure you know how high your monthly payment can go – the so-called ‘worst-case scenario’. An ARM has two ‘caps’ or limits on how large an interest rate increase is permitted: One cap sets the most that your interest rate can go up during each adjustment period, and the other cap sets the maximum total amount of all interest adjustments over the life of the loan. The rates on an ARM usually change once or twice a year, and there is typically a lifetime rate cap (or limit) on both the amount of each individual rate adjustment, and the total amount the rate can change over the whole term of the loan.
- Example: If your loan starts at 5 percent, has a 2 percent per-adjustment cap, and a lifetime adjustment cap of 4 percent, you know that your loan might go up to 7 percent the first time the rate changes. You also know that the rate can never go over 9 percent over the life of the loan (5 percent start + 4 percent lifetime cap). Only you can determine if you would feel comfortable paying this interest rate sometime in the future.
Some ARMs offer a conversion feature which allows you to convert from an adjustable-rate to a fixed-rate loan at certain times during the life of your loan. Ask your lender about this feature when researching ARMs. One important thing to know when comparing ARMs is that the interest rate changes on an ARM are always tied to a financial index. A financial index is a published number or percentage, such as the average interest rate or yield on Treasury bills.
HELOC Loan: What is a Home Equity Line of Credit?
A home equity line is a form of revolving credit in which your home serves as collateral. Because the home is likely to be a consumer’s largest asset, many homeowners use their credit lines only for major items such as education, home improvements, or medical bills and not for day-to-day expenses. With a home equity line, you will be approved for a specific amount of credit — your credit limit — meaning the maximum amount you can borrow at any one time while you have the plan. Many lenders set the credit limit on a home equity line by taking a percentage (say 75%) of the appraised value of the home and subtracting the balance owed on the existing mortgage.
Appraisal of home $100,000
Percentage x 75%
Percentage of appraised value $75,000
Less existing loan – $40,000
Potential credit line = $35,000
In determining your actual credit line, the lender will also consider your ability to repay by looking at your income, debts, and other financial obligations, as well as your credit history.
Home equity lines of credit often set a fixed time during which you can borrow money, such as 10 years. When this period is up, the plan may allow you to renew the credit line. But in a plan that does not allow renewals, you will not be able to borrow additional money once the time has expired. Some plans may call for payment in full of any outstanding balance. Others may permit you to repay over a fixed time, for example 10 years.
Once approved for the home equity plan, usually you will be able to borrow up to your credit limit whenever you want. Typically, you will be able to draw on your line by using special checks. Under some plans, borrowers can use a credit card or other means to borrow money and make purchases using the line. However, there may be limitations on how you use the line. Some plans may require you to borrow a minimum amount each time you draw on the line (for example, $300) and to keep a minimum amount outstanding. Some lenders also may require that you take an initial advance when you first set up the line.
What Should You Look for When Shopping for a Plan?
If you decide to apply for a home equity line, look for the plan that best meets your particular needs. Look carefully at the credit agreement and examine the terms and conditions of various plans, including the annual percentage rate (APR) and the costs you’ll pay to establish the plan. The disclosed APR will not reflect the closing costs and other fees and charges, so you’ll need to compare these costs, as well as the APRs, among lenders.
Interest Rate Charges and Plan Features.
Home equity lines of credit typically involve variable interest rates rather than fixed rates. A variable rate must be based on a publicly available index (such as the prime rate published in some major daily newspaper or a U.S. Treasury bill rate). The interest rate will change, mirroring fluctuations in the index. To figure the interest rate that you will pay, most lenders add a margin, such as 2 percentage points, to the index value. Because the cost of borrowing is tied directly to the index rate, it is important to find out what index and margin each lender uses, how often the index changes, and how high it has risen in the past.
Sometimes lenders advertise a temporarily discounted rate for home equity lines — a rate that is unusually low and often lasts only for an introductory period, such as six months.
Variable rate plans secured by a dwelling must have a ceiling (or cap) on how high your interest rate can climb over the life of the plan. Some variable rate plans limit how much your payment may increase and also how low your interest rate may fall if interest rates drop. Some lenders may permit you to convert a variable rate to a fixed interest rate during the life of the plan, or to convert all or a portion of your line to a fixed-term installment loan.
Agreements generally will permit the lender to freeze or reduce your credit line under certain circumstances. For example, some variable rate plans may not allow you to get additional funds during any period the interest rate reaches the cap.
Costs to Obtain a Home Equity Line.
Many of the costs in setting up a home equity line of credit are similar to those you pay when you buy a home. For example:
• A fee for a property appraisal, which estimates the value of your home.
• An application fee, which may not be refundable if you are turned down for credit.
• Up-front charges, such as one or more points (one point equals one percent of the credit limit).
• Other closing costs, which include fees for attorneys, title search, mortgage preparation and filing, property and title insurance, as well as taxes.
• Certain fees during the plan. For example, some plans impose yearly membership or maintenance fees.
• You also may be charged a transaction fee every time you draw on the credit line.
You could find yourself paying hundreds of dollars to establish a home equity line of credit. If you were to draw only a small amount against your credit line, those charges and closing costs would substantially increase the cost of the funds borrowed. On the other hand, the lender’s risk is lower than for other forms of credit because your home serves as collateral. Thus, annual percentage rates for home equity lines are generally lower than rates for other types of credit. The interest you save could offset the initial costs of obtaining the line. In addition, some lenders may waive a portion or all of the closing costs.
How Will You Repay Your Home Equity Line of Credit?
Before entering into a plan, consider how you will pay back any money you might borrow. Some plans set minimum payments that cover a portion of the principal (the amount you borrow) plus accrued interest. But, unlike the typical installment loan, the portion that goes toward principal may not be enough to repay the debt by the end of the term. Other plans may allow payments of interest only during the life of the plan, which means that you pay nothing toward the principal. If you borrow $10,000, you will owe that entire sum when the plan ends.
Are Payments Flexible?
Regardless of the minimum payment required, you can pay more than the minimum, and many lenders may give you a choice of payment options. Consumers often will choose to pay down the principal regularly as they do with other loans. For example, if you use your line to buy a boat, you may want to pay it off as you would a typical boat loan.
Whatever your payment arrangements during the life of the plan — whether you pay some, a little, or none of the principal amount of the loan — when the plan ends you may have to pay the entire balance owed, all at once. You must be prepared to make this balloon payment by refinancing it with the lender, by obtaining a loan from another lender, or by some other means. If you are unable to make the balloon payment, you could lose your home.
Can My Monthly Payment Change?
With a variable rate, your monthly payments may change. Assume, for example, that you borrow $10,000 under a plan that calls for interest-only payments. At a 10 percent interest rate, your initial payments would be $83 monthly. If the rate should rise over time to 15 percent, your payments will increase to $125 per month. Even with payments that cover interest plus some portion of the principal, there could be a similar increase in your monthly payment, unless the agreement calls for keeping payments level throughout the plan.
What if I Sell My Home?
When you sell your home, you probably will be required to pay off your home equity line in full. If you are likely to sell your house in the near future, consider whether it makes sense to pay the up-front costs of setting up an equity credit line. Also keep in mind that leasing your home may be prohibited under the terms of your home equity agreement.
What is an APR?
APR stands for annual percentage rate. It is the annualized cost of credit, expressed as a percentage. The APR calculation considers certain fees to reflect the cost of credit in addition to interest.
What is LTV?
LTV stands for loan-to-value, which is the ratio of the mortgage loan amount to the property’s value. For example, if your property is worth $100,000 and $80,000 is owed on the first mortgage, the LTV ratio is 80.