Home Mortgage - Guidelines for Home Mortgage

The typical home mortgage loan in the United States is written for a term of about 30 years and provides about 80 percent of the purchase price. In most cases the buyer must pay a loan fee, often expressed as “points,” or a percentage of the amount of the loan. The mortgage contract generally requires the lender to make uniform monthly payments which will amortize, or pay off, the loan by the end of the term. The fixed interest rate charged reflects the market conditions for money at the time the mortgage was written. In 1946 the interest rate was about 5 percent; in 1982 it peaked at 15 percent but went down in the late 1980s. A minor increase in the rate of interest results in a large increase in the monthly cost of owning a home. Over the term of a mortgage, interest payments can be greater than the purchase price. Interest rates on adjustable-rate mortgages vary with the market. These mortgages became increasingly popular into the 1990s, as did 10-percent rather than 20-percent down payments.

Savings and loan associations specialize almost completely in mortgage finance for owner-occupied housing. They lend money that has been deposited in savings accounts. Commercial banks and mutual savings banks also invest savings deposits in real estate mortgages. Life insurance companies make loans from their insurance policy premium-payment reserves. A significant number of mortgages are held by private individuals. Mortgage lenders consider whether an applicant has a good enough credit record and income to meet the monthly payments.

If a homeowner fails to make the monthly mortgage payments, the loan may be foreclosed. This means that the house will be sold to satisfy the debt and that the would-be homeowner will lose the house and any equity that has built up in it. In times of unemployment the foreclosure rate rises. However, a foreclosure sale in a community hard hit by unemployment may bring in less than the outstanding indebtedness, resulting in a financial loss to the lender. A lending institution may therefore be reluctant to foreclose and may try to work out a new payment schedule instead.

Homeowners can borrow additional money to reduce the cash down payment at the time of purchase or for personal expenses later on by placing a second mortgage against the property. In case of foreclosure the holder of the second mortgage gets paid after the holder of the first mortgage. Because of the greater risk to the lender, the interest rate on a second mortgage is higher.

Although home ownership is a well-established tradition in many nations other than the United States, in some of these nations the housing market is very different. In Japan, for example, mortgage credit institutions for buying homes are virtually nonexistent, and the high price of land has led to 100-year mortgages. In Italy, France, and Germany, rental housing in urban areas is often financed by large business concerns. With the help of the United Nations and other international agencies, Zimbabwe's government has offered home-ownership financing to low-income people.

Real estate brokers outside the United States are more likely to handle housing rentals than housing sales and are reluctant to exchange market information. Appraisal practices are highly developed in Great Britain but are almost unknown in many other countries. Until the 1980s in Communist countries there was no private ownership of income-producing property. Cooperative housing, however, was encouraged by government loans and subsidies.

An increasing number of apartments in the United States are owned by their occupants as cooperatives or condominiums. A cooperative is a multiple-dwelling project owned in common by its residents; a condominium is a multiple-dwelling project whose separate units are individually owned. The market for apartments in some areas is limited mostly to households without children.

New apartment buildings are sometimes financed by insurance companies or pension funds. Most are built by developers for sale to such groups as syndicates, which are partnerships of investors. Like buyers of single-family houses, investors in apartment buildings usually secure mortgage loans to pay most of the purchase price. For their investment the owners receive rental income and such advantages as reduced federal taxes on their personal income from other sources. Even more than buyers of single-family houses, they depend on the expert advice of appraisers, brokers, lawyers, property management firms, and accountants.

Using a study which included the influence of rising rates on house prices from 1975 to 2003, Mr. Youngblood found that a 1% increase in rates has led to an average decrease of about 1.6% in median home prices in 318 metro areas. If rates were to rise to 8.52% -- their highest level during the last monetary tightening in May 2000 -- median home prices should fall only by an average of 4.5% in 2006, and that decrease would not be enough to cause delinquency and loss problems, he wrote.

Homeowners with adjustable rate mortgages should carefully reassess their situation before refinancing. With economists projecting several interest rate hikes through 2006, financial advisers say now is the time for borrowers to take a second look at the loan terms of adjustable-rate mortgages. "Rates are likely to trend upward over the next year or two," warns Allen Fishbein, director of housing and credit policy for the Consumer Federation of America, a consumer advocacy group. "If consumers have less flexible incomes and don't have the resources to draw on to cover rising monthly payments, then ARMs may not be the best choice."

Last year, U.S. Army Capt. Samuel Williams and wife, Toni, a district manager at Target, chose a two-year adjustable-rate mortgage over a fixed-rate mortgage when they decided to build a five-bedroom, two-story home in San Antonio. Williams, who is the personnel manager with the San Antonio Recruiting Battalion, could be transferred before he is eligible for retirement in about two and a half years. The ARM, which has a starting fixed rate of 5.8% for two years, allowed the Williamses and their 2-year-old daughter, Jasmine, to afford a larger home than if they'd chosen a higher rate 30-year fixed mortgage. Thanks to the ARM, says Williams, "If we stay in San Antonio, we won't have to buy another house. We can grow into this one."

An adjustable-rate mortgage generally has a fixed-interest rate for a set number of years at the beginning, then the rate fluctuates. The fluctuations, called adjustments, boost or drop the initial interest rate and can occur monthly, quarterly, semiannually, or annually. ARM adjustments generally average 2% or less for borrowers with the best credit scores and can average up to 5% a year for borrowers with a credit score below 600.

The appeal of an adjustable-rate mortgage is that a borrower can cut his initial interest rate and initial monthly payments by one to two percentage points depending on the duration of the loan's fixed period. However, in a rising rate environment, monthly mortgage payments could soar.

Borrowers who have existing ARMs shouldn't worry. A quarter percentage point increase in the prime interest rate causes only an eighth of a percentage point increase in mortgage rates. In fact, Clarence Lewis III, a mortgage broker with Motown Mortgage in Houston, points out that "when the [Federal interest rate] moves, it doesn't necessarily mean that mortgages will move." He notes that mortgage rates didn't increase significantly in 2004 because the economy didn't grow very fast and because the dollar has remained weak.

Borrowers should read their loan agreements carefully to understand what will spark an increase in their mortgage rate and by how much. The interest rates of many ARMs aren't attuned to the prime interest rate but to bank deposits in specific regions of the country or to international indexes such as LIBOR (Lon don InterBank Offered Rate). Lewis says borrowers should find out the volatility of the index used to calculate their loan's mortgage rate, calculate the maximum possible adjustment in their monthly payments as their specific index rate climbs, and determine whether their budget can cover that hike. If your budget cannot handle the maximum allowed interest rate hike, an ARM is probably not for you.

Those with existing ARMs who are trying to decide whether to convert to a fixed-rate loan should tally up conversion fees (which vary) and any prepayment penalties and closing costs, and compare the total to the maximum possible increase in monthly payments they'd be subject to if they kept the ARM for the remainder of the time they plan to be in the home. "If you are going to move in one to two years, it does not make sense to convert [to a fixed-rate loan]," says Ed Powell, chief consumer officer and vice president at LendingTree.com, a lending and realty services Website. He explains that converting and paying closing costs--which will be about $2,000 for every $100,000 in mortgage costs--plus any additional conversion charges, would only save you money if you stayed in your home for the long term.