We’re in the process of buying a town house (met with another mortgage broker last week) and we’re trying to be as informed as we possibly can. This weekend while we were out of town,  I was looking up information about mortgages and reading paperwork from the bank we’re looking at using to get our mortgage.

I wanted to share some information that I found that I thought might be useful.

What is my mortgage interest rate?

Your mortgage interest rate is the annual rate you pay for the mortgage you take out.

What kind mortgages in regards to interest rates can I take out?

Some options available for the home buyers:

• A fixed rate (popular terms include 15 and 30 year): The interest rate remains the same through the length of the mortgage. This can be a smart choice if you want predictable payments over the long term of the mortgage.
• An adjustable rate (better known as an ARM):  The interest rate changes at specific times and the interest rate is subject to market conditions. There is a lifetime cap and annual limits to give some protection to radical increases, but your mortgage payments can still increase dramatically.

There are different repercussions based on your decision, so plan carefully.

How do rates on an ARM adjust?

Depending on your mortgage, your interest rate will be based on an index like the Prime Rate and the margin specified in your loan. The margin is the percentage point(s) above the index that the lender determines with your mortgage.

Each loan is unique, so check to see what different mortgage lenders are offering.  Your credit score can also be a factor in determining the amount the lender has for your margin.

Therefore your mortgage payments can rise and drop based on the index. Here is some information from the Consumer Handbook on Adjustable-Rate Mortgages on payment shock with ARMs with an example to illustrate it:

Payment shock may occur if your mortgage payment rises sharply at a rate adjustment. Let’s see what would happen in the second year if the rate on your discounted 4% ARM were to rise to the 6% fully indexed rate.

As the example shows, even if the index rate were to stay the same, your monthly payment would go up from $954.83 to $1,192.63 in the second year.

Suppose that the index rate increases 1% in one year and the ARM rate rises to 7%. Your payment in the second year would be $1,320.59.

That’s an increase of $365.76 in your monthly payment. You can see what might happen if you choose an ARM because of a low initial rate without considering whether you will be able to afford future payments.

If you have an interest-only ARM, payment shock can also occur when the interest-only period ends. Or, if you have a payment-option ARM, payment shock can happen when the loan is recast.

What are hybrid ARMs?

These loans have features of both fixed and adjustable rate loans. There is an initial period where the interest rates are fixed and then it will fluctuate based on the index and margin. I’ve usually seen this expressed in advertisement and sales pitches as 5/1 loans or 7/1 loans.

Taking the 5/1 as an example, the numbers reveal two things:

• The 1^st number is the length of the fixed period in years
• The 2^nd number is the time period of adjustments. If this is a 1, for example, then it adjusts annually.

There are some other ways of numbering the ARM loans, but the above is the most common.

Check to see if there are any penalties if you decide to refinance your arm loan or convert it to a fixed rate.

What mortage loan type is right for me?

Run the numbers and find out for yourself what will work with your budget and goals. Here are some things to keep in mind:

• How long are you planning on staying in your house? If you’re planning on moving relatively soon, renting may be a better option. Try the NY Times calculator and see how long you would have to stay in your house to break even when comparing to renting.
• Do you want stability with your mortgage payments? Fixed mortgages remain the same for the life of the mortgage loan. Adjustable rates can be lower for a time period, but no one can predict rates over the long term.

Run the numbers on the different mortgage types and interest rates.

Source: Consumer Handbook on Adjustable-Rate Mortgages

Your Thoughts

We applied for a 30 year fixed rate mortgage. We felt it was in our best financial interest to keep the interest rate steady. Right now the interest rate is relatively low, which is another bonus.

How about you? If you’re a home owner, what kind of mortgage did you get and why? If you’re planning on buying a home, what options are you looking at?

Photo Credit: pnwra

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Last week I was a part of LifeTuner’s chat on personal finances. I had a great time and we discussed a lot of financial topics. One question asked was, should some buy a house for the $8,000 tax credit.

Even though several bloggers themselves were home owners, many of them encouraged waiting it out instead of just jumping in.

It seems like we aren’t the only ones talking about the topic. Many stories are running on the news about using the different tax credits before they expire.

How Much Does it Cost To Be a Home Owner?

So you might save $8,000 with the tax credit, but can you afford the additional costs of home ownership, especially when this is for 30 years or more (some bills don’t go away after your pay your mortgage)?

Consider these financial obligations:

• Homeowner’s Insurance
• Private mortgage insurance
• Home Association Fees
• Property Tax
• Maintenance & Improvement

Now think about this, use a mortgage calculator to run your numbers, and then decide if you’re comfortable with that amount of money being taken out on a monthly basis. If you’re a bit hesitant about make it work, then pass on buying the house. Don’t buy a house, thinking that you’ll get a raise in a year or so and then you’ll have more breathing room. It’s not worth your long term financial goals to use the $8,000 tax credit.

Focus on Your Net Income, Not Your Gross Income

Many realtors advise looking at spending no more than 28% of your gross income for your housing. Looking at just your gross income that would mean that a family with $60,000 could spend no more than $1,400/month on mortage, taxes, etc. It doesn’t sound too bad, but if you look at net income, you’ll see it becomes a bit tighter in the budget.

Running $60,000 through paycheck calculator for a married couple (I used NC as the state), we get a monthly net income of  around $3,800. That $1,400 is now 36% of your take home. This situation can leave you house poor. Buying a house out of your price range can wreak your family’s finances for years.

Buying a House is Just One Financial Goal

It’s easy to get caught up in the emotions. Remember, though, that buying a house is not the end all. Don’t sacrifice other goals for this piece of property.

What other financial goals do you have? Do you want to be completely debt free? Do you want to volunteer more often? Do you plan on having kids some point in the future?  Do you want to start your own business? Would you like to retire early?

If your paycheck has the majority spent on housing, what will you have left over for your other goals and dreams?

What If You Really Want a House?

You have three options to look at carefully before you make a decision.

• Be patient and wait. Give yourself more time to have a bigger down payment. This will lower your mortage loan amount you’d need. Prices could stay lower than normal with unemployment problems continuing.
• Focus on getting a starter home. You can still buy a home, but you might consider getting something a more inside your price range, so you have bigger amount of wiggle room. If you’re buying your first home, a starter home can a better option. You may upgrades years down the road or you might find you like the house and stay.
• Go for the home. If you’re in a position to get the home you want, that’s great. Just make sure you double check it is something within your budget. Otherwise, consider the first two options.

As you can see, while the $8,000 tax credit can be a nice bonus for some home buyers, it should not be the determining factor for you to buy a house.

Your Thoughts

If you’re a home owner, what advice do you have to share? Do you have any regrets any victories you want to share?

Note: I will be out of town this weekend and may not be able to access the Internet.