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Permanent Link: http://ufdc.ufl.edu/IR00002625/00001
 Material Information
Title: Mortgage Alternatives: The Risks And Opportunities
Physical Description: Fact Sheet
Creator: Peart, Virginia
Publisher: University of Florida Cooperative Extension Service, Institute of Food and Agriculture Sciences, EDIS
Place of Publication: Gainesville, Fla.
Publication Date: 1995
 Notes
Acquisition: Collected for University of Florida's Institutional Repository by the UFIR Self-Submittal tool. Submitted by Melanie Mercer.
Publication Status: Published
General Note: "Publication date: September 1995."
General Note: "HE 3226"
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Source Institution: University of Florida Institutional Repository
Holding Location: University of Florida
Rights Management: All rights reserved by the submitter.
System ID: IR00002625:00001


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FactSheetHE3226 TheInstituteofFoodandAgriculturalSciencesisanequalopportunity/affirmativeactionemployerauthorizedtoprovideresearch,educational informationandotherservicesonlytoindividualsandinstitutionsthatfunctionwithoutregardtorace,color,sex,age,handicap,ornational origin.Forinformationonobtainingotherextensionpublications,cntactyourcountyCooperativeExtensionServiceoffice. FloridaCooperativeExtensionService/InstituteofFoodandAgriculturalSciences/UniversityofFlorida/ChristineTaylorStephens,DeanMortgageAlternatives:TheRisksandOpportunities1 VirginiaPeart,Ph.D.2Buyingahomeinvolvesadifficultdecision process.Today'smortgagesarecomplex,and homeownershipisnolongeranearlyrisk-free investment.Comparemortgagealternativestofind thebestbalanceofriskandopportunity.Figureout whichloanisthemostadvantageouscombinationof interestrate,up-frontcosts,totalcost,taxadvantages, monthlypaymentandtermsforyourparticular situation.Thisfactsheetwillhelpyouselecttheright mortgage.LONG-TERM,FIXEDRATE MORTGAGES(FRM)Description. Theinterestrateandmonthly principalandinterestpaymentsoftheFRMstaythe sameuntilthedebtispaidinfull.Theloanisusually amortizedover30years. CurrentPrevalence. TheFRMisthemost commontypeofmortgage.Asinterestratesdrop, FRMsbecomeaffordableandattractivetomore borrowers.Theyareavailablefrommanytypesof financialinstitutions. Advantages. TheFRMprovidesprotectionfrom anyincreaseintheinterestrateandmonthly payment.Itcreateslong-termtaxadvantagesand providesforastablehousingexpense. Disadvantages. FRMlenderschargeahigher interestrateforthistypeofmortgage.Thetotal interestcostsoverthelifeoftheloanaresubstantial. Thereisaslowequitybuild-up,especiallyintheearly years.ThenewerFRMsarerarelyassumable.You mustrefinancetotakeadvantageofadeclinein interestrates.Refinancingcoststotalabout3to4 percentofloanamount,soitdoesnotpayto refinanceoften. OtherCharacteristics. TheFRMusuallyrequires a20percentdownpaymentunlessyoupayfor mortgageinsurancetoprotectthelender.Private mortgageinsurancemaynotbeobtainablein depressedhousingmarkets.Lendersusuallyoffera rangeofinterestanddiscountpointcombinationsto choosefrom. MostSuitableBorrowers. Themostsuitable borrowersforFRMsincludethosewhohavefixed incomes,donotplantosellinthefuture,cannotrisk futureincreasesinmonthlypayments,seekalongtermtaxdeduction,andbelievethatinterestrateswill rise. Opportunityvs.Risk. Youpayextraforthe securityofpredictabilitycombinedwithminimal monthlypayments. 1.ThisdocumentisFactSheetHE3226,aseriesoftheHomeEconomicsDepartment,FloridaCooperativeExtensionService,InstituteofFood andAgriculturalSciences,UniversityofFlorida.Publicationdate:September1995.OriginallypublishedasFactSheetHB-12inJuly1993. ``MortgageAlternatives:TheRisksandOpportunities''byWandaW.Shelby,FamilyResourceManagement,andEleanorJ.Walls,Housing Specialist,ArkansasCooperativeExtensionService.Reviewed:September1995. 2.VirginiaPeart,associateprofessor,Housing,HomeEconomicsDepartment,CooperativeExtensionService,InstituteofFoodandAgricultural Sciences,UniversityofFlorida,GainesvilleFL32611.

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MortgageAlternatives:TheRisksandOpportunities Page215-YEARMORTGAGESDescription. Amortgagewhichisamortizedfor 15yearsisa15-yearmortgage.Itisusuallyafixed ratemortgage. CurrentPrevalence. Onceararity,the15-year mortgageisnowthesecondmostcommonloanfor refinancing. Advantages. Thistypeofmortgagesavesroughly halfoftheinterestthatwouldbepaidoverthelifeof a30-yearloan.Itrapidlybuildsequity.Lenders usuallychargeaslightlylowerinterestrateorfewer discountpointsthanfora30-yearloan. Disadvantages. Themonthlypaymentishigher thanlonger-termmortgages(thoughnotnearly double),thusreducingaffordability.Thehigher paymentstoreduceinterestcostscansometimesbe falseeconomy;someconsumerscouldrealizegreater benefitsbyinvestingtheextramoneyratherthan usingittoreducetheloantermandinterest payments.Thistypeofloanisusuallynotassumable. Consumerswillalsolosethetaxdeductionin15 years. OtherCharacteristics. SeeLong-Term,Fixed RateMortgage. MostSuitableBorrowers. Themostsuitable borrowersrefinancefromahigher-ratemortgageto alower-ratemortgage.Theycanaffordhigher paymentsnow,butexpecttoretireorhaveother majorexpenses(children'scollegetuition,etc.)after 15yearsaremostsuitableforthistypeofmortgage. Opportunityvs.Risk. Consumersmayincrease theirhousingbudgetnowtosaveoverthelongrun. Theywillstillpayextraforpredictabilitybutincurno riskofrisingpayments.ADJUSTABLERATEMORTGAGES(ARM)Description. TheinterestrateonanARMcan changeupwardordownward,usuallycausingchanges inthemonthlypayment.Insomecases,theloan termand/orprincipalmaychange. Theinterestrateisbaseduponarecognized financial``index,''nowmostoftentheone-yearU.S. Treasurysecuritiesyield.Theloan'sinterestrateis setatacertain``margin''orspreadabovetheindex rate(i.e.,a2percenthigherratethantheindexrate). Mostoftoday'sARMsareadjustedonceayear andhave``ratecaps''whichlimithowmuchthe interestratecanchangeupwardordownward.Twopercentannualcapsanda5to6percentcapincrease inthelifeoftheloanhavebecomestandard. ``Paymentcaps''(limitsonhowmuchthemonthly paymentcanrise)canleadto``negativeamortization'' (whentheprincipalbalanceordebtgrowsbecause monthlypaymentsarenotlargeenoughtocoverall theinterestdue).Paymentcapsarerarelyusedtoday andareveryrisky. Versionsofadjustablemortgagesarealsoknown asAdjustableMortgageLoans(AML),VariableRate Mortgages(VRM),orflexibleratemortgages. Advantages. Theinitialinterestrateislowerthan afixedrateloanusuallyby1to2percent,but wheninterestratesarehighthedifferencemaybe3 to4percent.Asaresult,monthlypaymentsstartout muchsmallerandqualifyingforanARMismuch easier. Ifinterestratesfall,theARMratealsofalls, meaninggreatersavingswithouthavingtoincurthe highcostsofrefinancing. Disadvantages. Ifinterestratesrise,thenthe loanrateandmonthlypaymentswillriseaccordingly ontheadjustmentdates.Ifyourincomedoesnot keeppacewiththeriseinpayments,youcouldbe forcedtoincurthecostsofrefinancingtoobtainan FRMatthecurrenthigherrateforprotectionagainst furtherincreases. ARMswithdeeplydiscountedinitial(``teaser'') ratesmaybecomemuchmorecostlyatthefirst adjustmentperiod,evenifmarketinterestrateshave notchanged.ARMswhichallownegative amortizationandARMswithoutratecapsarevery risky,butaregenerallyavoidedbylenderstoday, becauseofthehighdefaultratesassociatedwith them. ARMswithmoresafeguardshavehigherinterest ratesthanARMswithfewersafeguards.Long-term (30-year)ARMshaveslowequitybuild-up,similarto anFRM.OtherCharacteristics.SomeARMsare ``convertible''toanFRMattheprevailingratefora muchsmallerfeethanthecostofrefinancing

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MortgageAlternatives:TheRisksandOpportunities Page3(sometimesaslittleas$100).Conversionisgenerally allowedonlyduringcertainyearsoftheloan. Lendersmayofferarangeofinterestratediscountpointcombinationsfromwhichtochoose. Manylendersnowhavehigherborrower qualificationstandardsthaninthepast.Typically,the monthlymortgagepayment(plustaxesandinsurance) shouldnotexceed29percentofyourgrossincome, andyourtotaldebt(includinghousing)shouldnot exceed41percent.Thispaymentamountisoften baseduponthehighestofeither(a)theinitial mortgagerate,(b)10percent,or(c)thecurrentindex rateplus3percent. MostSuitableBorrowers. Thisborrowerexpects toownthehomeforlessthanfiveyears,acceptsthe riskoffuturehigherrates(inreturnforimmediate useofextracashthatwouldhavegoneintohigher FRMpayments),believesinterestratesaredeclining, anddoesn'twantahigher-rateFRM. Opportunityvs.Risk. Consumersmustlivewith theriskofhigherfuturepaymentsforcertainshorttermsavingsandpotentiallonger-termsavings.FEDERALHOUSINGADMINISTRATION (FHA)INSUREDLOANSDescription. HousingandUrbanDevelopment (HUD)insuresloansmadebyprivatefinancial institutionsforupto97percentofthepropertyvalue forupto30years.Theloansfinancehomesinboth urbanandruralareas.HUDinsuresvarioustypesof mortgageloans,adjustableratemortgageloans,and graduatedpaymentmortgageloans.Theinterestrate isestablishedbythemarket,notthegovernment. CurrentPrevalence. ThetypicalHUD-insured loanisafixedrate/fixedtermmortgageloan.HUDinsuredloansarereadilyavailable,butsomeofthe differenttypesofHUD-insuredloansmaynotbe availablelocally. Advantages. Thereisalowdown-paymentif thevalueislessthan$50,000,thedown-paymentis3 percentofthevalue;ifthevalueisgreaterthan $50,000,thedown-paymentis3percentofthefirst $25,000and5percentofthevalueinexcessof $25,000.HUD-insuredloansareassumableby qualifiedborrowers.Someclosingcostsmaybe financedintheloan.Noprepaymentpenaltiesmay becollected.Interestratesandpointsmaybeslightly lowerthanconventionalloans. Disadvantages. Thereisamortgageinsurance premiumthatistypicallyfinancedintheloan.The premiumvariesfrom2.3to3.8percentoftheloan amount,dependingontheloantermandtypeofloan. OtherCharacteristics. Maximumloanamount maybecapped,exceptforcertainhigh-costareas whichallowforlargerloanamounts.Thereareno limitsonfamilyincomeandnosubsidiesonthe monthlypayments. MostSuitableBorrowers. First-timehomebuyers andindividualspurchasingmoderatelypricedhomes arethetypicalHUDborrowers. Opportunityvs.Risk. HUD-insuredloans providethebuyerwiththeopportunitytopurchase withaminimaldownpaymentasopposedtothe20percentdown-paymentrequiredonaconventional loan.VETERANSADMINISTRATION(VA) GUARANTEEDLOANSDescription. VeteransAdministrationguaranteed loansprovidemortgageinsuranceforlow-andnodown-paymentloanstoeligibleveterans.Local lenders(notthegovernment)supplytheloans.The VAsetsthemaximuminterestrate.VAloans includeFRM,15-yearfixed-ratemortgages,and others. CurrentPrevalence. VAFRMsarewidely availabletoeligibleconsumers. Advantages. Eligibleveteranspaynomortgage insurancepremiumsandmayobtaina100percent loan-to-valuemortgage(nodownpayment),uptoa fairlyhighloanlimit.Such100percentfinancing takesgreatestadvantageoftaxreformprovisions. VAloansofferlow(belowmarket)interestrates. DisabledvetsdonotpaytheVAfundingfee(1.875 percentofloanamount).Thesellerpaysany discountpoints.TheVAsetslimitsonclosingcosts inmostareas.Thereisnomaximumlandvalueto theloanamountandnopre-paymentpenalty. Disadvantages. Non-veteransareineligible. Discountpointsareusuallychargedandifaseller paysthem,thepriceofthehousemaybehigher.The littleornodown-paymentrequiredresultsinboth

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MortgageAlternatives:TheRisksandOpportunities Page4largerdebtandlargermonthlypayments.Ifthe homedepreciates,thehousingdebtmayexceedthe valueofthehouseandthesaleofthehomewould notcovertheloan.Anydownpayment,closingcosts, orpointscannotbeborrowed.Processingtimeis30 days. OtherCharacteristics. VAloanshaveafunding feeof1.875percentoftheloanamount.Adown paymentisrequiredforanyloanamountabovethe amountspecifiedbythelender. MostSuitableBorrowers. Themostsuitable borrowerisaveteran(especiallyafirst-timebuyer) andthosewishingtorefinancetotaphomeequity (getcashback).FARMERSHOMEADMINISTRATION(FMHA) RURALHOUSINGLOANSDescription. FmHAprovideshousingloansto applicantswhoarewithoutadequatehousing,lack sufficientresourcestoobtainhousing,andareunable toobtaincreditfromothersources.Loansare availabletothosewhohavethecapacitytorepaythe loan,canpersonallyoccupythehome,andhavea goodcredithistory.Applicantsmustpurchaseor buildinaneligibleruralareaasdefinedbyFmHA. Loansmaybemadetoaneligibleapplicanttobuy, build,rehabilitate,improve,orrelocateadwellingto beusedasapermanentresidence.Incomelimitsare setbystateformulas. CurrentPrevalence. FmHAloansareavailableto homebuyerswhoqualifybecauseoftheirincomeand thelocationoftheresidence.FmHAofficesare locatedthroughoutthestate. Advantages. Theseloansmakehomeownership (andhomeimprovement)possibletothosewho perhapscouldnototherwiseobtainadequatehousing. Theinterestrateanddownpaymentvarywith householdincome.Closingcostsarelow.Borrowers whosufferareductioninincomemayreceive governmentassistance.Loantermsmaybearranged forlongertermsthanforconventionalmortgages. Disadvantages. Thistypeofhomefinancingis availableonlytothosewhomeetthecriteriaoutlined byFmHA. OtherCharacteristics. FmHAarrangesall aspectsoftheloanorigination,includingappraisal andinspection.Theapplicantpaysforthelegal servicesnecessarytoguaranteeasatisfactorytitleto thesite,creditreports,andotherincidentalloanclosingcosts.Exceptforcreditreports,these expensesmaybeincludedintheloan. MostSuitableBorrower. Themostsuitable borrowersarelow-income,rural,first-timehome buyers.OTHERMORTGAGEVARIATIONSAcceleratedAmortization. Thesemortgagesare ado-it-yourselforstructuredshorteningoftheloan termbymakingadvanceprincipalpaymentsonloans thathavenopre-paymentpenalty.Theycanresultin muchlowertotalinterestcostandaresimilartobiweeklymortgages.Discussthisvariationwithyour lender. HomeEquityConversions. Withhomeequity conversions,retiredhomeownersmaytaptheequity intheirhomestosupplementtheirincomewhile remaininginthehome.Theymaybestructuredin severalways.Someareloanplanswherethe homeowneraccumulatesadebttobepaidoffatsome futuretime(usuallybysaleofthehouseafterdeath). Loanplansareunlikelytoappealtolendersin depressedhousingmarkets. Otherversionsaresplit-equityplanswherethe elderhomeownersellsthehouse(toarelativeor investor)andtheequityissplitintoownershiprights belongingtothebuyerandoccupancyrights maintainedbytheelderforlife.Inotherwords,the buyerleasesthehomebacktotheformerownerfor lessthanthemonthlyannuitycreatedfromthehome sale. Homeequityconversionsarenotwidelyoffered. Suchloansrequirecomplexlegalprecautionsand shouldbecarefullystudiedbythehomeowner.COMMONMORTGAGEFEATURESOthermortgagefeaturesareAssumableLoans andSellerFinancing.Assumablemortgages,suchas VAandFHAloans,allowabuyertotakeovera seller'soriginalmortgage.Thebuyermustthen obtainthebalanceofthepurchaseprice.Iflenders agreetoanassumption,theymayreviewthenew buyer'scredithistoryandadjusttheinterestrateof theloantocurrentmarketconditions.Manyfixedratemortgageswrittensincethelate1970scontaina ``due-on-sale''clause,however,whichprohibitsan

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MortgageAlternatives:TheRisksandOpportunities Page5assumption.Thisprotectsthelenderswhenbuyers wanttoassumesellers'existinglow-ratemortgages. Withsellerfinancing,asellerprovidesallorpart ofabuyer'sfirstorsecondmortgage.Whilesellers mayofferaslightlybelow-marketinterestrate,they mayalsorequireaballoonpaymentoftheentireloan balancewithinafewyearsofrefinancingatmarket rates.Toeliminatepossiblepitfalls,seller-financed loansshouldbepreparedandreviewedbyan attorney. OtherOptionsincludeballoon,reverseannuity, sharedappreciation,andrentingwithanoptionto buy. Selectingthe``right''mortgageisnotaneasytask. Amongthefactorstoconsiderareyourcurrentand projectedincome,yourmarginaltaxbracket,current marketconditions,thesizeofyourinvestment portfolio,andhowlongyouplantoliveinthehouse.ADDITIONALFINANCINGTIPSIfyouhavesavingsorexpecttoreceivea substantialprofitfromthesaleofyourcurrenthome, youcanreduceyourmortgagesubstantiallybymaking a20-to30-percentdownpayment.Thedifference between8-percent,30-year$40,000and$50,000loans, forexample,is$73amonthor$876ayear. Donotignoretheimpactofpointswhen comparingmortgageloans.Thelowestinterestrate isnotalwaysthebestchoice.Thelengthoftimeyou remaininahousewilldeterminewhethertochoose alowermortgageratewithmorepoints (recommendedifyoustaymorethan5years),ora highermortgageratewithfewerornopoints (recommendedifyouexpecttomovewithin5years). Theannualpercentagerate(APR)ofamortgage measuredintotalinterestcost,includingpointsand fees,canhelpinmakingcomparisonsamongfixedrateloans. RememberthatPrivateMortgageInsurance (PMI)isalmostalwaysrequiredwithdownpayments oflessthan20percentofthepurchaseprice.PMI willaddabout1/4percenttoyourmortgageinterest rate.Thecostisusuallyaddedtoeachmonthly payment.Undergovernmentmortgageguidelines adoptedinearly1989,homeownerscandroptheir PMIinaslittleas2years.Ifhomeequityincreases to20percentormoreduetohomeimprovementsor reductionsinloanprincipalor25percentormore duetomarketappreciation,PMIcoveragecanbe dropped.Contactyourlenderfordetails.Ifyouare ``stretching''toqualifyforamortgage,a1-yearlowinterestARMwillusuallybuythemosthouseforthe lowestinitialrateandmonthlypayment.Thetradeoff,ofcourse,isthattheinterestratecouldincrease inthefuture. WhenshoppingforanARM,askaboutthe maximumannualandlifetimeinterestrate.Then consulta``mortgagepaymenttablebook''tofindthe correspondingmonthlypaymentandconsiderifyou couldstillaffordtheloanwhenthepaymentisatits highest. Ifyoucanaffordthehighermonthlypayment,biweeklyand15-yearloansbuildupequitymuchfaster thanothertypesofmortgages.Theyalsooffsetthe effectsoftaxreform,whichreducedthevalueofthe mortgageinterestdeductionbyloweringmarginaltax brackets. Anticipateproblemsthatcouldaffectyourloan beforeyouapply.Trytoreduceyourdebtload,for example.Reviewacopyofyourcreditrecord.(See FactSheetHE3217, HomeBuyingandYourCredit Report,forhowtogetyourcreditreport.)Bring everyneededdocumenttoyourfirstmeetingwitha lenderincludingthecontracttobuyyourhouse,anet worthstatement,loanrecords,statementsfrombanks andbrokeragefirms,W-2s,andoneortwoyears' previoustaxreturns. Aboveallelse,doyourhomework!Askquestions andcompareloanfeaturesandclosingcosts,aswell asmonthlypayments.Oneadvantageofhavinga multitudeofchoicesisthatyouarelikelytofinda mortgagethatfitsyourlifestyle.