What to Look for in a Home Loan
Home loans come in all shapes and sizes with an endless assortment of positive aspects and flaws. The term “home loan” applies today not only to a standard mortgage, but also to the widely popular practice of home refinancing. It’s probably valuable in today’s housing market for the home owner and shopper to understand both.
What Do You Need in a First Mortgage?
It’s not enough today to go into the home buying process without some understanding of how long you intend to keep your home. The average stay for a family in a purchased home is nine to eleven years. If your career or your family status – kids on the way, kids leaving – suggest that the home you’re buying may be back on the market in less than ten years, it can change your entire home loan strategy.
For conservative, prudent shoppers often the fixed rate mortgage has great appeal. The mortgage premium is the same every month, for thirty years. The only thing that changes is the amount of tax deduction you get from the interest every year, as the early years of a mortgage are always front-loaded with heavy interest payments and very little principal money.
If you think you’ll be moving in five years or seven, an adjustable rate mortgage (ARM) may have more appeal. You can take advantage of the low initial payments and be out of the house by the time the mortgage rage readjusts. If the home has appreciated in value, you should be able to move along to the next one nicely.
Banks will usually set a limit to the acceptable monthly payment a borrower may make towards debt. For that reason, many people use ARMs to get into a house that they could not afford under the terms of a fixed rate mortgage. Generally, people who make this choice assume that a viable refinancing option will be available when the ARM adjusts, or that household income will have risen high enough to match the increased monthly payment.
Building Refinancing into Your Home Loan Plans
From 2000 to 2005, the rapid escalation in home values across the nation made home loan refinancing an important part of the consumer loan landscape. That escalation has slowed dramatically in some regions and ground to a halt in others. For that reason, taking out an initial home loan with the intent of refinancing it is a riskier proposition than it was just two years ago. However refinancing should be a part of your financial and family planning, at least as an option to be considered at some point.
As we’ve mentioned, utilizing an adjustable rate home loan in order to get into “as much house as possible” is a reasonable course if you expect home income to rise in the near term. It also makes sense if you intend to be in the home long enough to make refinancing the original loan in order to obtain better interest rates than the original ARM. Your credit may have improved, interest rates may be better. Or, interest rates may be not as attractive as your original ARM rate but you may be refinancing into a smaller loan, having paid down some equity – and, of course, you can opt for another ARM. In either case, however, you have to build the cost of the loan origination into the calculation of what is the best deal for you.
Home Loans to Extract Cash
If you’ve been in the house long enough to have paid down the principal on the loan and/or seen your house appreciate in market value, you are a candidate for a home equity loan. This is a loan granted with the equity you hold in the house used as collateral, and provides cash for other purposes you may have in mind.
Generally home equity loans are for ten years and are fixed rate notes. You are provided the money in a lump sum and may do whatever you wish with it. Since many people take out home equity loans for the purpose of consolidating debt, this type of home loan comes with a disclaimer – an asterisk next to the title, if you will. Debt consolidation usually is required because of unrestrained spending, and that behavior has to change upon issuance of the debt consolidation home loan. Otherwise, you’ll be paying off additional debt with no equity left to borrow against.
Other people use home equity loans to make home improvements, to make investments with greater returns than the interest rate on the loan, to send kids to college, and so forth. The important thing to realize about home equity loans is that, while they can be an important infusion of cash at a critical point in your life, you are mortgaging your house back to at or near one hundred percent of market value. That means you’ll realize very little from the sale of the home should you elect to sell in the near future. Don’t take out a home equity loan if you plan to move in the next few years.
The Interest Only ARM
A home equity line of credit (HELOC) is not exactly a home loan. It is, however, utilizing the equity you hold in your home to obtain cash. You can draw down on your HELOC as you need to and make payments only on what you owe. Usually HELOCs are adjustable rate loans, unlike home equity loans or second mortgages. Once again, statistics show that the principal reason people open HELOCs is to consolidate debt. And once again, borrowing to lessen a debt load is only worthwhile if you stop spending as well.
Second Mortgages, or Cash Out Refinancing
Cash out refinancing means replacing your original mortgage with a new one that reflects the equity you hold in the home. The cash left over after you pay closing costs on your new mortgage is a windfall similar to that provided by a home equity line of credit. The principal reason for this type of home loan, however, is to obtain a better interest rate. Refinancing your entire mortgage will require most of the closing costs that were involved in the original mortgage – several thousand dollars. You have to calculate the interest savings against loan origination costs, as well as the reduced tax deduction that results from lower interest rates on your home loan.
Here again, family planning is a key component of financial decision making. If you’re going through the process of replacing your mortgage in its entirety, it makes sense that you be in the home long enough to pay for the closing costs on the new home loan and to put yourself in a position to sell the home at a price that allows you to buy another one.
Determining Which Home Loan is Best
The number of option available both for mortgages and for refinancing options is mind-numbing. If you are considering a home loan of any type, you need to develop a flat list of associated costs so that you can compare a number of options presented by lenders. You need to consider the monthly payments involved, whether it is a primary mortgage or some sort of secondary note. Tax deductions and loan origination costs must be factored in, along with the effect on your cash flow.
Finally, it is always good to be one home loan ahead in your planning. Unless you are buying the home you intend to stay in forever, give some thought to when you might be moving on and how you will pay your home loan costs until then – whether refinancing might be necessary, how your credit rating can be improved so that you qualify for better loans, and so forth. A typical life of home ownership isn’t about a single home loan anymore; it involves several and that requires a look into the future, as hazy as it may seem.
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