Understanding Adjustable-Rate Versus Fixed-Rate Mortgages

Although there is a wide array of mortgage types and home loan programs, the two most common loans chosen by modern homeowners are fixed-rate and adjustable-rate mortgages. While the current marketplace features a myriad of varieties within these two primary loan types, the most important step when it comes to finding the best home loan for you is understanding the genuine difference between each loan type. It’s only with this understanding you’re able to make the best decision for your financial future and stability.

Fixed-Rate Mortgages | A Basic Understanding

These are perhaps the most common mortgage loans as their interest rate is just as its name implies. Throughout the duration of the loan, the interest rate on the loan is fixed, which means it does not adjust. However, the amount of each payment applied to the principle and interest of the loan will adjust from payment to payment. Regardless, the actual monthly payments will never increase or decrease. This is ideal for those who wish to have a stable monthly payment, which helps simplify budgeting.

The primary advantage of a fixed-rate mortgage payment is the loan is protected from erratic and potentially high increases to payments. If this is your first time dealing with home loans, many find a fixed-rate mortgage to be ideal as it’s easy to understand; however, if you have a lower-than-desired credit score, you could be facing high interest charges throughout the duration of the loan, which results in paying tens of thousands of dollars on pure interest. Therefore, it’s a popular choice among those with good credit and perhaps an unwise choice for those with lower credit. If you are wondering what is a good credit score, it’s usually anything above 750.

Adjustable-Rate Mortgages | A Basic Understanding

Just as its name suggests, an adjustable-rate mortgage is a mortgage where the interest rate fluctuates as the market changes. The majority of these loans begin with a fixed-rate that’s relatively lower than the market average. However, this fixed-rate portion only lasts one to 10 years. After the introductory time frame is completed, the interest rate then adjusts based on the current market. The rate of adjustment is based upon a pre-arranged frequency, which is made clear before you agree to the loan terms.

For many, an adjustable-rate mortgage is the ideal choice as its initial rate is quite low, which makes the monthly payment affordable. However, after this preliminary period, the monthly payment can significantly increase based upon the current market values and the percentage of increase the lender places on the increased rate. In fact, some adjustable-rate mortgages are designed so the interest rate, and ultimately the mortgage payment, can literally double within a span of a few years. Therefore, before you agree to an adjustable-rate mortgage, you should carefully consider the future financial requirements of the loan.

The Three Elements to Qualify for a Home Loan

If you’re interested in buying a home, then you’ll be required to qualify for a home loan. Although there are many elements that go into the qualifying process, the majority of home lenders feature three primary elements when determining the eligibility of a borrower. If you’re interested in purchasing a home, but aren’t quite sure where to begin, take a moment to review the following three elements. After doing so, you’ll have a greater understanding of what lenders look for when determining your eligibility and qualifications.

The First Element – Pre-Qualify for a Home Loan

Perhaps the most important element in qualifying for a home loan is obtaining an official notice of your eligibility. When you pre-qualify for a home loan, you provide a potential lender with basic-level information regarding your current financial stability and situation. Information such as income, assets and debts are utilized to determine the potential loan amount and interest rate of a loan. While this is an important step, it is in no way the final loan decision. However, when you’re pre-qualified you’re able to walk into the home buying process with confidence knowing the rough loan amount you’ll receive.

The Second Element – Gaining Pre-Approval for Maximum Negotiating Power

It’s vital to understanding pre-qualifying and pre-approval are two completely separate entities. While you may qualify for a loan, it in no way guarantees a loan package similar to the original quote. However, when you are pre-approved for a loan, the lender physically states they will approve a loan request of a specific amount based upon documentation provided in your application. As a buyer, this gives you greater negotiating power as it informs the seller you are ready to begin the closing process as you’re already approved for a loan. This approval process also helps you understand the price range that’s best for you.

The Third Element – Factors for Final Loan Approval

So you’ve found the ideal home in a price range that’s comfortable for you and your family. Now it’s time to go in for the final loan approval. Although there are many factors that go into determining your final loan package, the following three factors are considered universally important:

  • Debt-to-Income – Much like any other loan request, whether that be an auto loan or a credit card, the mortgage lender will review your overall debt-to-income ratio, which is often referred to as DTI. This ratio is determined by reviewing your annual gross income and comparing this to your monthly debt responsibilities. The majority of lenders will not lend to a borrower with a DTI greater than 43 percent. In fact, many lenders features significantly lower DTI maximums, such as 30 percent.
  • Liquid Assets – Along with ensuring you make enough money to cover your bills each month, the majority of lenders will only approve a long if you have ample assets for a “reserve” account, which is money leftover after paying bills for emergencies. As the home loan industry become more strict regarding its lending practices, the majority of lenders are only going to lend to those who they deem are financially stable enough to afford their bills without hindering or lowering the qualify of their life.
  • FICO Credit Scores – Your credit score determines not only your eligibility for a loan, but also your overall interest rate. While FHA loans feature low credit score minimums, which average around a FICO credit score of 500, the majority of conventional loan lenders feature a minimum FICO of 620. However, as stated above, many lenders are tightening their requirements to ensure the financial health of their borrowers. Therefore, don’t be surprised if you aren’t approved for a loan with below a 700 credit score. Ideally, you’ll have a FICO score between 740 and 850 credit score before applying for a home loan.

Top 3 Most Common Mistakes Home Buyers Make

Whether this is your first home buying experience or your fifth, the process of purchasing a home is likely one of the largest expenses you’ll ever encounter. While there are literally hundreds – if not thousands – of books and courses designed to enhance your home-buying education, millions of Americans make strikingly similar mistakes throughout this process. Although your situation may be unique, the following mistakes are universal throughout the entire mortgage industry. If you wish to enhance your knowledge, and potentially save tens of thousands of dollars, continue reading to uncover the top 5 most common mistakes home buyers make.

Mistake #1 – Foregoing the Pre-Approval Process

Make no mistake, being pre-approved for a mortgage is not the same as being pre-qualified. This is perhaps the most confusing situation because many home buyers – and some lenders – use these terms interchangeably. However, there are several notable differences between each term.

When you’re pre-approved by a mortgage lender, you receive a realistic loan amount based upon your qualifying factors. Not only does this provide you with a better understanding of what you can afford, but in many cases, when you walk into a potential deal with pre-approval from a lender, you have an edge over any other competitive buyers. Therefore, before you ever begin your search for a home, it’s important to become pre-approved for a specific loan amount. You may then use this amount as a compass to guide you to a home in which you can realistically afford.

Mistake #2 – Not Verifying Your Credit Score

The loan amount and interest rate is not solely based upon your income or other assets. Rather, the final figure is primarily determined by your overall credit score. Home buyers who forgo the process of delving into their credit score are robbing themselves from a positive purchasing experience. Your credit score not only qualifies you for a loan, but is used by mortgage lenders to determine whether or not you’re a viable candidate for a mortgage. As a general rule of thumb, if your credit score is within the mid-600s or below, many lenders are wary to engage in a lending agreement.

In many instances, if the lender approves your loan, the result will be a less-than-ideal mortgage packet, which typically consists of a high interest rate and undesirable mortgage terms. Therefore, prior to seeking out a mortgage loan, perform a full investigation into your credit score from the top three credit bureaus. If you find your score is within the aforementioned range, consider delaying your home purchase until your score reaches the good credit score range (at least 700). It’s at this point the majority of mortgage lenders will provide you with an excellent mortgage amount and low interest rates, which will save you tens of thousands of dollars throughout the life of the loan.

Mistake #3 – Not Asking the Tough Questions

While there are many questions you must ask a mortgage lender and real estate agent, the most important questions are those you must ask yourself. It’s not uncommon to “fall in love” with a specific home – regardless of its price – and then suddenly you’re stuck with a mortgage payment you can barely afford or a location that ends up being less-than-ideal. Therefore, before ever purchasing a home, make sure to ask yourself the following questions:

  • Can I afford the mortgage payments without suffering in other areas of my life?
  • Are the taxes on the property too expensive?
  • Can I comfortably pay the monthly utilities without suffering in other areas of my life?
  • Can I afford to pay for the regular and unforeseen maintenance on the home?
  • How long do I see myself living in the home?
  • Can I comfortably afford any fees associated with the property, such as HOA fees and zoning ordinances?

How to Chose an Ideal Monthly Mortgage Payment

Have you finally decided to make an offer on a home? Are you ready to move forward with the purchasing process, but are wary about the monthly payments you’ll soon face? Choosing your monthly mortgage payments is an excellent starting point when determining if you can comfortably afford a new home. Many mortgage lenders will ask you how much you wish to spend per month on the mortgage payment. This is one of the most important decisions you’ll make when selecting a mortgage because it ultimately determines whether or not you can afford a home. The following tips are designed to assist in this process, and with careful consideration, you’ll be able to find the ideal mortgage that allows you to move into your dream home without suffering financially.

Choosing a Monthly Mortgage Payment | Types of Interest Rates

The type of interest rate you select will ultimately determine how much your monthly payments will be. For millions, choosing the wrong interest rate formula means the difference between living comfortably and living a tight financial life (or worse). There are four primary mortgage interest rate plans. Each features an advantage and disadvantage and should be carefully considered for both short-term financial stability and long-term financial comfort:

  • Interest Only Mortgages – An interest only mortgage is when you only pay on the interest of a loan for a specified amount of time. For example, in a 30-year interest only loan, you’ll only pay off the interest of the loan for 10 years. After that, the monthly payments are recalculated and you’ll begin to pay on the principle balance. Because the actual loan amount will not be reduced until the interest only period is complete, this is only an option for those who wish to live within their home throughout the entire mortgage terms.
    Negative Amortization Mortgages – These mortgages allow a borrower to pay less than the interest only amount. AS each payment is made a deferred interest is created, which is then added to the principle balance. Therefore, as time goes on, the actual amount of the principle balance increases. Although this type of mortgage results in a stable (and low) monthly payment, you’ll ultimately end up paying more on the principle balance.
  • Fixed Rate Mortgage – This is perhaps the most common mortgage option as it secures a stable monthly payment, which never changes, because the interest rate is locked in throughout the duration of the loan. Although this type of loan features a set interest rate, if you applied for the loan when your credit score was lower than it will be in the future, you may end up paying more than you should.
  • Adjustable-Rate Mortgage – Many homeowners select an adjustable-rate mortgage because the beginning of the loan features a very small interest rate; however, as the loan matures, the interest rate begins to adjust. Typically, these mortgage packages feature a fixed interest rate for the first year to seven years of the loan. However, after this time period the interest rate begins to fluctuate based upon current market rates. This can ultimately result in a monthly mortgage payment that’s unaffordable. One of the most common mistakes made by a homeowner is believe he’ll move out before the interest rates begin to fluctuate. Unfortunately, many end up staying in their home and are facing high interest rates with equally high mortgage payments.