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What should you ask if you're considering an interest-only or option ARM? Here's a checklist of the 20 most important questions to consider:

Mortgage Lender Basic Loan Checklist
1. How much can I borrow with a specific loan program given my income, debts and credit standing? What is the specific loan product being used to calculate your borrowing ability? To answer this question effectively, lenders will need to examine your credit report.
2. How much of a cash downpayment is required? Example: Borrow $300,000 with 3 percent down and you'll need $9,000 in cash at closing for the downpayment.
3. How much total cash is required for closing? For a home purchase, the amount of money required at closing includes the downpayment plus closing expenses such as taxes, transfer fees, title insurance (except in Iowa) and other costs. With a refinance, the equity in the home typically eliminates the need for a downpayment, however other closing costs remain. Ask the lender for a "good faith" estimate of closing costs.
4. How long is the loan term? Typically a loan term is 15 or 30 years.
5. Is the interest rate fixed or adjustable? (Some interest-only products have fixed rates for the life of the loan, most do not. All option ARMs have variable rates.)
6. How long does the "start" period last? This is typically the time when the borrower pays a below-market interest rate or can make small monthly payments. Usually the start period lasts anywhere from three to five years, but start periods can be longer or shorter. For instance, a 5/1 ARM would have a fixed-rate and payment for five years and then the rate and payment will adjust once-a-year for the remainder of the loan term.
7. Is the interest rate fixed or variable during the start period? (Some loans have fixed monthly payments during the start period but the interest rate can vary. See comments regarding "negative" amortization below.)
8. How often does the interest rate change during the start period? After the start period?
9. What's the maximum periodic payment increase at each adjustment? This is often limited to a 7.5 percent increase. Example: If the monthly payment in year one is $800 the maximum payment in year two would be $860.
10. What is the interest rate cap? Example: This might be 2 percent a year and 6 percent over the entire loan term.
11. How often do payments adjust? Be aware that with some loan formats the monthly payment during the start period may so low that it is not enough to cover the interest cost.
12. If the monthly payment is insufficient to cover interest costs, does the loan allow negative amortization? With negative amortization any monthly interest not paid is added to the loan balance.
13. If the loan balance grows to a certain point, perhaps 115 to 125 percent of the original loan amount, does the lender have the right to call the loan? A $200,000 loan would have to increase to $230,000 to reach 115 percent of its original value, $250,000 to reach 125%.
14. When is the loan recast or recalculated? This usually happens ever five years. When a loan is recast it means the monthly payment is adjusted so that the loan can be fully repaid (or "amortized") over the remaining loan term. Caution: If interest rates rise and if there has been negative amortization or no amortization (as with interest-only loans), monthly payments can rise significantly. The payment cap usually does NOT apply when a loan is recast.
15. How is the interest-rate calculated for an adjustable-rate mortgage? With adjustable rates the interest level is generally a product of an "index" such as the going rate for Treasury securities plus a "margin," a set amount such as 2.5 percent. If the index is a 4 percent and the margin is 2.5 percent, the interest rate would be 6.5 percent.
16. With regard to option ARMs, what are your payment choices during the start period? Typically the choices are to pay as if you were amortizing the loan over 30 or 15 years, to make interest-only payments or to make low monthly payments during the start period that create negative amortization.
17. What are the highest possible payments for the loan you prefer at the end of years one, two, three, four and five for a loan with a five-year start period?
18. Imagine that your option ARM allows negative amortization each month during the entire five-year start period. What's the highest monthly payment and loan balance you might face one month after the start period ends?
19. Does your loan have a prepayment penalty? How much? How long must you have the loan before it's no longer subject to a prepayment penalty? If there is a prepayment penalty, are you allowed to make some prepayments, say 20 percent per year?
20. What's the basic contact information for your loan officer? E-mail? Work phone? Company name? Physical address? Website?
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Excerpt from 20 Questions: What Are The Secrets of Today's Loans?

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