Different Mortgage Strategies

When it comes to paying for a home, buyers today have an almost unlimited number of financing options from which to choose. They have before them a real "mortgage smorgasbord"-a table full with exotic names like "ARMs," "balloons," and "buy downs." 

Many involve financing assistance from the home seller. Others are from regular financial institutions like mortgage companies, banks and savings and loans. Here's a run-down on the main types of financing every home buyer should know today. Interest rates are intended for illustration only. 

Conventional/VA/FHA

Conventional Mortgage. A conventional loan is an indebtedness or mortgage made between a lending institution and a borrower without a third party participant, such as VA or FHA. Most types of conventional loans are paid off in equal monthly payments spread over 15, 25 or 30 years. The interest rate stays the same for the life of the loan, therefore the monthly principal and interest payment also remains constant. 

Terms of a conventional loan vary among lenders, but basically a loan can be obtained with as little as 3% down payment. When the down payment is less than 20% it is, in most cases, necessary for the loan to have private mortgage insurance to protect the lender. 

Example: The buyer purchases a $150,000 home. Typically, the lender will require a down payment of $30,000 or 20% of the purchase price. Assuming 8% market rate; $120,000 loan amount; 30 years, $880.52 monthly payment. With private mortgage insurance, however, the lender would lower the down payment requirement to 5%, or $7,500, which increases the monthly payment. (Lenders refer to private mortgage insurance as "PMI.") 

Advantage: Fixed rate financing is straight forward and easy to understand. Using private mortgage insurance normally adds up-front costs but new PMI plans allow premiums to be financed or paid monthly. 

VA Loan. The VA does not lend money, it guarantees a portion of the loan so that lenders who originate the loan feel comfortable with their risk. Qualified veterans can take out loans up to $203,000 with no down payment. VA-guaranteed loans can be combined with second mortgages and are assumable upon qualifying by any future buyer. Payments may be fixed for full term. 

Example: The veteran agrees to buy a home for $100,000. With no down payment, the loan amount is $102,000 (includes a minimum 2% VA Funding Fee) for 30 years, and say the VA interest rate is 8%, plus "points" paid by either buyer or seller. The monthly payment for the $100,000 loan will be $748.40. 

Advantage: No down payment necessary. 

FHA Loan. Strictly speaking, FHA does not make a loan; rather, it insures loans, which makes lenders willing to finance home purchases on favorable terms. 

With an FHA loan the down payment can be as little as 2.25% of the purchase price or 3% of the first $25,000 of the purchase price, 5% of the next $100,000, and 10% on the remainder. 

Points (prepaid interest) can be charged by the lender, but since the FHA rate is no longer regulated by HUD, the purchaser may negotiate the rate and points. 

FHA is now charging an up-front Mortgage Insurance Premium (MIP) fee. This fee can be financed in with the loan or paid in cash at settlement. It is 2.25% of the loan amount, if financed. In addition to the upfront 2.25% fee (which can be financed into the loan), FHA now charges a monthly MIP of .5%. 

Example: The buyer of a $100,000 home in Maryland, would make a down payment of approximately $2,250, resulting in a base loan amount of $97,750 and a total loan amount of $99,949, including the financed M.I.P. At a rate of 8%, the monthly principal and interest would be $773.39, plus $40.73 for the monthly M.I.P., for an adjusted payment of $814.12. 

Advantage: Low down payment and low interest rates. Fixed or adjustable rates available. Especially designed for first-time home buyers. 

Owner Assisted

Second Mortgage. The seller of the house lends the buyer enough to make up the difference between the purchase price and the down payment + first-mortgage balance. (A commercial lender may also make this kind of loan). The terms, including the interest rate, are based on buyer/seller agreement. It is often a short-term (5-to-15 year) loan; sometimes "interest only" payments being made until the term date, when the balance is due. A buyer can then pay off the loan or refinance. 

Example: A $100,000 home offers a $40,000 assumable first mortgage balance; to pay $60,000. the buyer puts $14,000 down and takes a 15-year second mortgage for $46,000 at 10%. Monthly payments on the first mortgage are $283; second mortgage, $494. The total, $777, is less than if the purchaser had taken out a new first mortgage for $86,000 at 8% ($821.86) and the second pays off after 15 years. 

Advantage: Well suited for the buyer with a small amount of cash for a down payment, but with a monthly income high enough to handle both mortgages.

Buy Down Mortgage Plan. The seller (who in this case might be the home owner, the builder, or a third party) puts additional cash "up front" with the lender when the loan is closed, in exchange for a lower interest rate in the initial year(s) of the mortgage. 

Example: Assume that the current "Market" rate is 8%. With the purchase price at $100,000, the buyer makes a down payment of $14,000. Monthly payments on the balance of $86,000 would amount to $631.04. However, the seller/builder/third party can "buy down" the interest rate by paying the cost differential between the higher and lower rate monthly payments at 6%, the monthly payments are $515.61 for the first year. 

Advantage: Lower interest rates and lower monthly payments. Buy downs allow more potential buyers to qualify for a loan.

Owner Financing. Owners may finance first, second, third or fourth loans. They may lend their equity back as a first mortgage (often called a "take back") or help the buyer in other ways. One form of owner financing (sometimes called a "balloon" mortgage) bases monthly payments on a 30-year-loan scale, but requires the balance of the mortgage to be paid at the end of a short period, say 5 to 7 years. 

Example: The house price is $100,000. The seller will take a down payment of $14,000. The balance ($86,000 less monthly payments made on the principal) will be due in five years. Interest rate, 10%. Monthly payments, $755-nearly all of it interest. At the end of five years, the buyer must pay the seller $83,054, the balance of the mortgage. At that time, the new owner will seek other financing. 

Advantage: Lower initial interest rate. If interest rates have declined by the time the balloon payment is due, the buyer can secure less expensive financing.

Institution Assisted

Assumable Mortgage. Buyer "takes over" or assumes the mortgage obligations of the seller (with concurrence of the lender). Down payment is the difference between new purchase price and the existing mortgage balance. Interest doesn't change, which is usually lower than today's rates. 

Example: With a house price of $100,000, the seller holds an assumable mortgage at 7%. The balance of the mortgage is $40,000. (The seller originally paid $50,000 for the house in 1969). Down payment, $60,000. Monthly payments on balance of seller's mortgage, $283. A substantial portion of the $60,000 might be financed by a second mortgage. 

Advantage: An opportunity for the buyer to get financing at bargain rates and seller has substantial marketing advantage if home is competitively priced.

Adjustable Rate Mortgage (ARM). The interest rate may go up or down over the years, and it is keyed to a financial market index. Monthly payments may also be adjusted on a periodic schedule. Many ARMs set a maximum adjustment on possible increases to interest rates and monthly payments, and/or overall floor or ceiling for life of the loan. The initial rate is often lower than conventional fixed rate financing. 

Example: Buyer purchases a $100,000 home. Down payment $14,000; loan amount, $86,000; interest rate at start, 6%; monthly payments (interest and amortization) at start, $516.00. Interest rate adjusted annually to reflect Treasury bills; maximum annual rate adjustment is 2%; life-of-the-loan rate cap is 12%; monthly payments adjusted every year. 

Advantage: Initially, monthly payments are lower and less income is required to qualify. If interest rates decline, the rate is adjusted downward.

Balloon Mortgages. A balloon mortgage is typically a loan which must be paid off after a certain period. The advantage they offer is an interest rate that is lower than a 30-year mortgage. Balloons may range in duration from 5 to 7 or 10 years. If the 30-year fixed rate quote was 8%, the 7-year balloon may be as low as 7.5%, providing lower payments for the 7-year period. One point to consider, however, is that the investor may but does not have to guarantee to extend the loan past the balloon date even though most balloon plans contain provisions for optional refinancing. 

Example: See example under the heading of "Owner Financing."

The exact terms of any financing are subject to the requirements of the investors in each specific case. Choosing the "best" method depends on the circumstances of the individual. We will be most happy to fully explain the home buyer's options for financing.

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