Home Buyer's Guide

Types of Mortgages

Lenders usually use two basic formulas to determine how much of a mortgage you can afford. They may very slightly depending on the lending institution you 're using, but most lenders follow the same guidelines. There are many programs available, both conventional and governmental. Your lender can work with you to find one that fits your specific financial needs.

Conventional Loans, with a Fixed Interest Rate, generally require that your mortgage expenses, which include the principal, interest, taxes and insurance : (PITI) do not exceed 28 percent. of your income. A fixed-rate loan has an interest rate which is constant throughout the loan term.

There is another ratio used with long-term debt. Long-term debt is considered to be any payments extending for nine months or longer. Your long-term debt must not exceed 36 percent of your gross income to qualify for a fixed-rate Loan.

For example, if you annual income is $60,000, divide that by 12 and your gross monthly income is $5,000. For a conventional loan, multiply $5,000 by 1. 28 percent to get $1,400. The total of your monthly a mortgage expense, plus any long-term debt must not exceed $1,800. ($5,000 multiplied by 36 percent, equals $1,800).

Adjustable Rate Mortgages (ARMs) have a low interest rate for the first year or two, after which it is adjusted regularly, relative to a specific index, with payments going up or down, accordingly. The most a commonly used indexes are rates on certain treasury notes or the average regional or national cost -of -money to savings and loan associations. Some lenders use their own cost-of-funds, over which, unlike other indexes, they have some control.

Mortgage expenses for an ARM should not a exceed 26 percent of your income. For an adjustable- rate mortgage your long-term debt must not exceed 33 percent of your gross income.

With a Federal Housing Administration (FHA) Loan, mortgage expense is not to exceed 29 percent, and long-term debt-to-income ratio is to be no more than 41 percent.

Graduated Payment Mortgages offer fixed interest rates and a 30-year term. Payment amounts start at a low level, then gradually increase over a few years to an amount that will amortize the loan in the 30-year period.

Growing Equity Mortgages offer fixed interest rates and a 30-year term. Monthly payment amounts are at the 30-year rate for a specified period of time, then increase 2 to 5 percent annually.

Short-term Balloon Mortgages are fixed rate, discount-priced, and based on the Federal Reserve's discount rate, plus a .25 to 8 percent local add-on. They are keyed to a 30-year payout, and must be paid off or refinanced in 7 to 10 years.

Fifteen-year Mortgages are discount priced slightly higher than balloon mortgages, plus the local add-on. The interest rate is low, and payoff is fast.

Ten-year Mortgages offer a discount, priced slightly higher than balloon mortgages, plus the local add- on. To take advantage of this discount, you must be financially able to handle a 10 year amortization schedule.

Mortgage rates, terms, requirements and settlement service costs vary from lender to lender. For the best deal, check out commercial banks, savings and loans, credit unions and insurance companies. Compare rates and requirements on appraisals, credit reports, surveys, title searches, settlement service costs, title insurance fees, points and prepayment penalties.

Ask lenders if their own customers get more favorable terms. It may pay to transfer accounts or credit cards to their facility. Ask about an open-end clause, allowing you to borrow more money later without refinancing. Ask potential lenders to provide a written good-faith estimate, comparing each type of mortgage line by line. Ask about capping an adjustable rate mortgage, to limit the amount the interest can increase each adjustment period and overall. To avoid negative amortization (interest being added to the mortgage's principal), make sure your payment amount rises with each interest rate increase. Ask about a conversion provision allowing you to change to a fixed rate mortgage at a specified point in the life of the ARM.