Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, September 26, 1994 TAG: 9409260008
SECTION: BUSINESS PAGE: A10 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
DATELINE: LENGTH: Long
If you understand the various mortgage options, requirements, rates and fees, you can more easily determine how much you can afford to spend on a home and how much you can comfortably finance.
How much can you afford to borrow?
The amount of the loan, the type of loan you select, as well as its annual percentage rate, will determine the amount of your monthly payments.
As a general rule, lenders recommend that monthly mortgage payments do not exceed 25 to 28 percent of a borrower's gross monthly income.
Another rule of thumb is that monthly mortgage payments combined with other long-term debt payments, such as car and student loans, should not exceed 36 percent of gross monthly income.
Although some lenders may issue you a mortgage if you have a higher debt-to-income ratio, the accountants warned to keep in mind that the more debt you have, the more difficult it will be to make those mortgage payments.
Most mortgage lenders require that you make a down payment of at least 20 percent of the cost of the home. If you put down less money, you usually must buy private mortgage insurance, which will add to monthly payments.
One of your mortgage options is a fixed-rate loan. Despite the wide array of mortgage options available today, fixed-rate mortgages still are the most popular. They offer security, since both the interest rate and monthly payment are fixed for the period of the loan.
You can obtain a fixed-rate mortgage for terms of 15 to 30 years. Usually, the shorter the loan term, the lower the interest rate and the faster you will build equity in your home. Shorter terms, however, generally mean higher monthly payments.
That means you may need more income to qualify for these mortgages than for a conventional 30-year mortgage, however.
When deciding the length of the loan term, the accountants advised, carefully consider your financial ability to meet the monthly mortgage payments now, as well as five, 10 and 15 years down the road.
Remember as well that even if you can't afford a 15-year or 20-year mortgage, you can take out a 30-year loan and periodically make extra payments on the loan principal. In this way, you can pay off your loan more quickly.
A fixed-rate biweekly mortgage also enables you to build up equity in your home quickly. That's because you make 26 payments annually, which is equivalent to 13 monthly payments a year instead of 12. Over the life of the mortgage, these extra payments can save you a substantial amount of interest.
Adjustable-rate mortgages save the most in interest costs during the early years of the loan, but they have the greatest long-term risk.
Adjustable-rate mortgages offer a low interest rate for a short period of time, usually from one to three years. After that, the interest rate is adjusted either annually or every few years, based on market conditions.
As a result, your monthly payment can increase over the life of the loan. Lenders use different indexes to determine when and how much the interest rate will decrease or increase.
Some lenders also offer annual and lifetime caps on interest rates - typically two percentage points annually and six percentage points over the life of the loan. The accountants said this is an important adjustable-rate mortgage feature that could protect you in the event interest rates rise significantly.
Some adjustable-rate mortgages include a provision enabling you to convert the loan to a fixed-rate mortgage for a modest fee.
Michael Hincker, manager of the Roanoke office of Mortgage Service America, said fixed-rate mortgages are the most popular home loans among Roanoke-area buyers.
But any time rates spike up, he said, people start thinking about adjustable-rate mortgages.
Buyers can benefit from an adjustable mortgage, he said, if they plan to be in their homes for a short period. An example would be a person who expects a job transfer in three years.
Others who might want to consider an adjustable-rate mortgage, he said, are those who believe they will have more money in the future. This might be a family expecting a much higher salary, a couple whose children will be out of college in a few years or someone who plans to pay off a major debt soon.
The mortgage can be adjusted to the person's situation. Hincker said people can take a fixed loan for terms of three, five, seven or 10 years. It then converts to an adjustable mortgage with annual rate changes.
A family expecting nominal salary adjustments should avoid an adjustable-rate mortgage, according to Hincker.
Usually an adjustable-rate mortgage has an initial rate that is about three percentage points below the fixed rate, Hincker said. But, he added, anyone who uses an adjustable-rate mortgage is a risk-taker because risk comes with that reward.
Another option is a balloon mortgage.
Like adjustable-rate mortgages, balloons enable you to obtain a fixed interest rate for a short period. Typically, balloon mortgages are structured for seven years.
At the end of that period, you must pay the remainder of the loan in full or refinance the loan at the then-current interest rate.
Additionally, the Federal Housing Administration and the Department of Veterans Affairs make low-interest loans available to qualified individuals. Your bank or mortgage company should be able to provide you with the information about requirements to qualify.
When determining the amount and type of mortgage you can afford, remember that in most instances mortgage interest is fully tax-deductible. In order to deduct mortgage interest, the CPAs said, the loan must be secured by the home you purchase or construct. The lien on the house must be recorded according to state law.
by CNB