I became a first-time homeowner two years ago, and in the process I learned a lot about mortgages -- many things surprisingly interesting or unexpected. Here are 10 things that you may not know about mortgages.
1. You can buy a house with a down payment of as little as 0%. That's right, no down payment at all; 100% financed via a mortgage. You may even find a government agency that will help with your closing costs. These options aren't available to everyone, but first-time homeowners and/or homebuyers of limited means may be able to find good deals here and there.
2. Adjustable rate mortgages (ARMs) come in many varieties. You might think of an ARM as a mortgage with an interest rate that goes up or down each year. Some ARMs do work that way, but consider this: If you're pretty sure you'll be staying in your home for just five or six years, you can get something called a "5-1" ARM, where the rate is fixed for the first five years, after which it fluctuates each year. Whereas 30-year fixed mortgage rates can be as low as around 5.5% these days, 5-1 ARMs are in the 4.5% range. That 5-1 ARM might save you $100 per month, or $1,200 per year. There are 7-1 ARMs, 10-1 ARMs, and many other related beasts as well.
3. Adjustable rate mortgages are generally limited in how much they can adjust each year. Naive renter that I was, I always assumed that ARMs were especially risky, because if interest rates skyrocket over one or two years, your mortgage rate will also skyrocket. Fortunately, I learned that ARMs typically have caps on how much rates can increase each year. (Still, over the long run, they can increase a lot.)
4. Small changes in interest rates can make a big difference. Imagine that you recently got a 30-year fixed mortgage on a $200,000 house at 6.5% with a 20% down payment. That results in a monthly mortgage payment of roughly $1,011. You might not think it's worth refinancing now, with rates around 5.625%, but think again. The same mortgage at that interest rate results in monthly payments of about $921. The difference per month? $90, or $1,080 per year. If closing costs on the refinancing will be $2,000, just divide that by $90 to see how many months it will take before you break even: 22. So if you're planning to live in your home for at least two years, refinancing may well be worth it.
5. Mortgage brokers can be very useful for many people. My uncle is actually a mortgage broker, but I'd never really discussed mortgages with him until I began house-hunting. A good mortgage broker will advise you on what kinds of mortgages would best suit you, and will find you the best rate and deal that he or she can, searching through the loan products of many lenders. Of course, just as with many professions, there are conflicts of interest in the mortgage broker biz that can result in you getting ripped off. One way to avoid that is to read up on the topic and to seek out ethical mortgage brokers. The Mortgage Professor's website is a good place to learn more.
6. Not everyone needs a mortgage broker. Mortgage brokers tend to be most useful when you've got some financial issues, such as a poor credit history. If you've got a pristine credit report and plan to put at least 20% down on your new home, you may be able to just walk into a few local banks and ask for their best rates.
7. You might find even more attractive mortgage rates from your local credit union. For example, at the time of this writing, my local bank is offering 30-year fixed-rate mortgages for 5.625% (with no points). But a credit union to which I belong sports 5.375% rates for the same thing. If you don't belong to a credit union, you may be able to join one through a family member, your workplace, or an association to which you belong.
8. Some websites will crunch many helpful numbers for you. Using mortgage payment calculator you can learn exactly how much of each mortgage payment will go toward the principal of the loan vs. interest. (This might be useful to know, since the interest portions are deductible on your tax return.)
9. Paying points on your mortgage may or may not be smart. Points are an extra fee you pay (or don't) when you close on your mortgage. They're expressed as a percentage of the loan -- so on a $200,000 loan, two points would be $4,000. By paying points upfront, you can often get a lower interest rate. This is a sensible thing to do if you're pretty sure you'll be sticking with that home and mortgage for many years. If you're planning to only be there a while, skip the points.
10. The world of mortgages isn't a static one. Here's an intriguing, relatively new option -- portable mortgages. In 2003, E*Trade (NYSE: ET) introduced mortgages that you can take with you, transferring them from one house to another if you move. You pay a small premium in interest rates for the privilege, but given that most people these days don't stay put for 30 or even 15 years, this option could well be worth it. I won't be surprised if additional lenders begin offering portable mortgages soon.
There's much more to learn about mortgage options. Wachovia (NYSE: WB), for example, is offering a mortgage designed for teachers. Merrill Lynch (NYSE: MER) introduced blended-rate mortgages last year, featuring advantages of both fixed-rate mortgages and ARMs. Freddie Mac (NYSE: FRE) offers multifamily mortgages. Lots of lenders offer interest-only loans and other extreme mortages.
I hope you found at least some of the above tidbits interesting.
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