All About Adjustable-Rate Mortgage in San Antonio

Adjustable-rate mortgages (ARMs) differ from fixed-rate mortgages in that the interest rate and monthly payment can change over the life of the loan. ARMs also generally have lower introductory interest rates vs. fixed-rate mortgages. Before deciding on an ARM, key factors to consider include how long you plan to own the property, and how frequently your monthly payment may change.

Why choose an adjustable-rate mortgage?

One reason buyers consider adjustable rate mortgage in San Antonio is that the low initial interest rates offered by ARMs make them attractive during periods when interest rates are high, or when homeowners only plan to stay in their home for a relatively short period. Similarly, homebuyers may find it easier to qualify for an ARM than a traditional loan. However, ARMs are not for everyone. If you plan to stay in your home long-term or are hesitant about having loan payments that shift from year-to-year, then you may prefer the stability of a fixed-rate mortgage.

Components of adjustable-rate mortgages

Adjustable-rate mortgages have three primary components: an index, margin, and calculated interest rate.

• Index

  The interest rate for an ARM is based on an index that measures the lender's ability to borrow money. While the specific index used may vary depending on the lender, some common indexes include U.S. Treasury Bills and the Federal Housing Finance Board's Contract Mortgage Rate. One thing all indexes have in common, however, is that they cannot be controlled by the lender.

• Margin

  The margin (also called the "spread") is a percentage added to the index in order to cover the lender's administrative costs and profit. Though the index may rise and fall over time, the margin usually remains constant over the life of the loan.

• Calculated interest rate

  By adding the index and margin together, you arrive at the calculated interest rate, which is the rate the homeowner pays. It is also the rate to which any future rate adjustments will apply (rather than the "teaser rate," explained below).

Adjustment periods and teaser rates

Because the interest rate for an ARM may change due to economic conditions, a key feature to ask your lender about is the adjustment period--or how often your interest rate may change. Many ARMS have one-year adjustment periods, which means the interest rate and monthly payment is recalculated (based on the index) every year. Depending on the lender, longer adjustment periods are also available. An ARM can also have an initial adjustment period based on a "teaser rate," which is an artificially low introductory interest rate offered by a lender to attract homebuyers. Usually, teaser rates are good for 6 months or a year, at which point the loan reverts back to the calculated interest rate. Remember, too, that most lender will not use the teaser rate to qualify you for the loan, but instead use a 7.5% interest rate (or calculated interest rate if it is lower).

Rate caps

To protect homebuyers from dramatic rises in the interest rate, most ARMs have "caps" that govern how much the interest rate may rise between adjustment periods, as well as how much the rate may rise (or fall) over the life of the loan. For example, an ARM may be said to have a 2% periodic cap, and a 6% lifetime cap. This means that the rate can rise no more than 2% during an adjustment period, and no more than 6% over the life of the loan. The lifetime cap almost always applies to the calculated interest rate and not the introductory teaser rate.

Payment caps and negative amortization

Some ARMs also have payment caps. These differ from rate caps by placing a ceiling on how much your payment may rise during an adjustment period. While this may sound like a good thing, it can sometimes lead to real trouble. For example, if the interest rate rises during an adjustment period, the additional interest due on the loan payment may exceed the amount allowed by the payment cap--leading to negative amortization. This means the balance due on the loan is actually growing, even though the homeowner is still making the minimum monthly payment. Many lenders limit the amount of negative amortization that may occur before the loan must be restructured, but it's always wise to speak with your lender about payment caps and how negative amortization will be handled.

Understanding Different Types of Loans

Today's homebuyer has more financing options than have ever been available before. From traditional mortgages to adjustable-rate and hybrid loans, there are financing packages designed to meet the needs of virtually anyone.

While the different choices may seem overwhelming at first, the overall goal is really quite simple: you want to find a loan that fits both your current financial situation and your future plans. Though this article discusses some of the more common loan types, you should spend time talking with different lenders before deciding on the right loan for your situation.

General categories of loans

Most loans fall into three major categories: fixed-rate, adjustable-rate, and hybrid loans that combine features of both.

• Fixed-rate mortgages

As the name implies, a fixed-rate mortgage carries the same interest rate for the life of the loan. Traditionally, fixed-rate mortgages have been the most popular choice among homeowners, because the fixed monthly payment is easy to plan and budget for, and can help protect against inflation. Fixed-rate mortgages are most common in 30-year and 15-year terms, but recently more lenders have begun offering 20-year and 40-year loans.

• Adjustable-rate mortgages (ARM)

Adjustable-rate mortgages differ from fixed-rate mortgages in that the interest rate and monthly payment can change over the life of the loan. This is because the interest rate for an ARM is tied to an index (such as Treasury Securities) that may rise or fall over time. In order to protect against dramatic increases in the rate, ARM loans usually have caps that limit the rate from rising above a certain amount between adjustments (i.e. no more than 2 percent a year), as well as a ceiling on how much the rate can go up during the life of the loan (i.e. no more than 6 percent). With these protections and low introductory rates, ARM loans have become the most widely accepted alternative to fixed-rate mortgages.

• Hybrid loans

Hybrid loans combine features of both fixed-rate and adjustable-rate mortgages. Typically, a hybrid loan may start with a fixed-rate for a certain length of time, and then later convert to an adjustable-rate mortgage. However, be sure to check with your lender and find out how much the rate may increase after the conversion, as some hybrid loans do not have interest rate caps for the first adjustment period. Other hybrid loans may start with a fixed interest rate for several years, and then later change to another (usually higher) fixed interest rate for the remainder of the loan term. Lenders frequently charge a lower introductory interest rate for hybrid loans vs. a traditional fixed-rate mortgage, which makes hybrid loans attractive to homeowners who desire the stability of a fixed-rate, but only plan to stay in their properties for a short time.

Balloon payments

A balloon payment refers to a loan that has a large, final payment due at the end of the loan. For example, there are currently fixed-rate loans which allow homeowners to make payments based on a 30-year loan, even thought the entire balance of the loan may be due (the balloon payment) after 7 years. As with some hybrid loans, balloon loans may be attractive to homeowners who do not plan to stay in their house more than a short period of time.

Time as a factor in your loan choice

As has been discussed, the length of time you plan to own a property may have a strong influence on the type of loan you choose. For example, if you plan to stay in a home for 10 years or longer, a traditional fixed-rate mortgage may be your best bet. But if you plan on owning a home for a very short period (5 years or less), then the low introductory rate of an adjustable-rate mortgage may make the most financial sense. In general, ARMs have the lowest introductory interest rates, followed by hybrid loans, and then traditional fixed-rate mortgages.

FHA and VA loans

U.S. government loan programs such as those of the Federal Housing Authority (FHA) and Department of Veterans Affairs (VA) are designed to promote home ownership for people who might not otherwise be able to qualify for a conventional loan. Both FHA and VA loans have lower qualifying ratios than conventional loans, and often require smaller or no down payments.

Bear in mind, however, that FHA and VA loans are not issued by the government; rather, the loans are made by private lenders but insured by the U.S. government in case the borrower defaults. Remember too, that while any U.S. citizen may apply for a FHA loan, VA loans are only available to veterans or their spouses and certain government employees.

Conventional loans

A conventional loan is simply a loan offered by a traditional private lender. They may be fixed-rate, adjustable, hybrid or other types. While conventional loans may be harder to qualify for than government-backed loans, they often require less paperwork and typically do not have a maximum allowable amount.

Getting Your Finances in Order

A crucial step in starting your search for a new home is having a clear idea of your financial situation. By getting a handle on your income, expenses and debts, you'll have a much better idea of what you can afford and how much you'll need to borrow.For lenders to verify this information, though, they're going to need to look at your financial records. It is also important to remember that you should include records for each person who will be an owner of the house. So before you even visit the bank, make sure you'll be able to provide copies of these important documents:

• Paycheck Stubs

Remember that lenders are most interested in your average income. Not only will they want to see this month's paycheck, but also how much you've been making for the past two years. Steady employment is also more attractive to lenders, so if you've been hopping from job to job, be prepared to discuss the reasons why.

• Bank Statements

In order to qualify you for a loan, most lenders will also ask you for copies of your bank statements. Ideally, they'd like to see a steady history of savings--or at the very least, that you're not bouncing checks every month.

• Tax Records

It's always a good idea to save copies of your tax returns, especially if you're self-employed. If you own your own business, it's important to note that lenders generally consider your income as the amount you paid taxes on--not the gross income of the business.

• Dividends & Investments

Lenders will usually consider long-term investment dividends, as well as your investment portfolio, when evaluating your income.

• Alimony/Child Support

If you receive steady payments as part of a divorce settlement or for child support, you can also include this as part of your gross income. Just remember that lenders will want to see a copy of your divorce/court settlement verifying the amount of the payments.

• Credit Report

Virtually every lender will want to see a copy of your credit report as part of the loan application process. The report lists all of your long-term debts, as well as your payment history. In general, they will require you to pay for the credit report (approximately $50), but if you have a recent copy, they may accept that instead.

How Mortgage Loans Work

Excluding property taxes and insurance, a traditional fixed-rate mortgage payment consist of two parts: (1) interest on the loan and (2) payment towards the principal, or unpaid balance of the loan. Many people are surprised to learn, however, that the amount you pay towards interest and principal varies dramatically over time. This is because mortgage loans work in such a way that the early payments are primarily in interest, and the later payments are primarily towards the principal.

In the beginning... you pay interest

To help calculate monthly payments for loans based on different interest rates, lenders long ago developed what are known as "amortization tables." These tables also make it fairly easy to calculate how much money of each payment is interest, and how much goes towards the principal balance.

For example, let's calculate the principle and interest for the very first monthly payment of a 30-year, $100,000 mortgage loan at 7.5 percent interest. According to the amortization tables, the monthly payment on this loan is fixed at $699.21. The first step is to calculate the annual interest by multiplying $100,000 x .075 (7.5 %). This equals $7,500, which we then divide by 12 (for the number of months in a year), which equals $625. If you subtract $625 from the monthly payment of $699.21, we see that:

• $625 of the first payment is interest
• $74.21 of the first payment goes towards the principal

Next, if we subtract $74.21 (the first principal payment) from the $100,000 of the loan, we come up with a new unpaid principal balance of $99,925.79. To determine the next month's principal and interest payments, we just repeat the steps already described

Thus, we now multiply the new principal balance (99,925.79) times the interest rate (7.5%) to get an annual interest payment of $7,494.43. Divided by 12, this equals $624.54. So during the second month's payment:

• $624.54 is interest
• $74.67 goes towards the principal.

Note: In Canada, payments are compounded semi-annually instead of monthly.

Equity

As you can see from the above example, even though you pay a lot of interest up front, you're also slowly paying down the overall debt. This is known as building equity. Thus, even if you sell a house before the loan is paid in full, you only have to pay off the unpaid principal balance--the difference between the sales price and the unpaid principle is your equity.

In order to build equity faster--as well as save money on interest payments--some homeowners choose loans with faster repayment schedules (such as a 15-year loan).

Time versus savings

To help illustrate how this works, consider our previous example of a $100,000 loan at 7.5 percent interest. The monthly payment is around $700, which over 30 years adds up to $252,000. In other words, over the life of the loan you would pay $152,000 just in interest.

With the aggressive repayment schedule of a 15-year loan, however, the monthly payment jumps to $927-for a total of $166,860 over the life of the loan. Obviously, the monthly payments are more than they would be for a 30-year mortgage, but over the life of the loan you would save more than $85,000 in interest.

Bear in mind that shorter term loans are not the right answer for everyone, so make sure to ask your lender or real estate agent about what loan makes the best sense for your individual situation.

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Saving for the Down Payment

Saving funds for a down payment should be part of an overall program to get your finances in order prior to shopping for a home. This includes rounding up financial records, examining your spending habits, and setting a budget you can live with. Remember, too, that the down payment is not the only up-front expense. An allowance for closing costs should also be included in your savings budget.

How much is required?

The down payment is usually expressed as a percentage of the overall purchase price of the home, and varies depending on the lender, the type of financing and amount of money being lent. In the past, the typical down payment was 20%, but in recent years lenders have been willing to offer conventional financing with as little as 3% down. U.S. Government financing programs, such as those offered by the Dept. of Veterans Affairs (VA) or the Federal Housing Administration (FHA), also require minimal down payments.

Private mortgage insurance

Typically, if your down payment is less than 20% of the purchase price, lenders will require you to carry PMI, or private mortgage insurance. This insurance protects the lender in case of loan default, and usually involves an up-front payment at closing, as well as a monthly premium. However, once you have paid off 20% of the loan, you can request the policy be canceled. Some lenders cancel the premium automatically, while others require you to make a request in writing.

Gifts

If you are having trouble saving enough money, many lenders will allow you to use gift funds for the down payment--as well as for related closing costs. The gift may come from family, friends or other sources, but remember that lenders usually require a "gift letter" stating the gift doesn't have to be repaid. In addition, some lenders will also require you to pay at least a portion of the down payment with your own cash. Thus, if you plan to use gift money to purchase your house, ask your lender about their policies regarding gifts.

Earnest money

Buyers are usually required to deposit earnest money with the seller when they make an offer. If the offer is accepted, the earnest money is then credited towards the down payment. The amount varies widely depending on the seller and local custom, but be prepared from the outset to have funds earmarked for this purpose.

Don't forget closing costs

In addition to the down payment, you will also need to save for additional fees associated with the loan. Known as closing costs, these charges cover items such as title insurance, documentary stamps, loan origination fees, the survey, attorney's fees, etc. When you submit your loan application, lenders are required to supply you with a good faith estimate of your closing costs.

Some buyers are surprised by the amount of the closing costs, which can easily run into the thousands of dollars. Remember, though, that closing costs can be negotiated with the seller. For example, you may agree to pay the full asking price in exchange for the seller paying all the allowable closing costs.

When Should You Pay Points on a Loan?

When it comes to comparing interest rates for a mortgage loan, homebuyers often have the option of choosing a loan with a lower interest rate by paying points. Simply put, a point is equal to 1 percent of the loan amount. For example, with a $100,000 loan, one point equals $1,000. Points are usually paid out-of-pocket by the buyer at closing. Paying points may seem attractive, because a lower interest rate means smaller monthly payments. But is paying points always a good idea? The answer generally depends on how long you plan to stay in the house. Let's look at an example:

Bob and Betty Smith are shopping for loan rates on a $150,000 home. Their bank has offered them a 30 year loan at 7.5 percent with no points. This works out to a monthly payment of $1,049.

However, their bank has also offered them a loan at 7 percent if they agree to pay 2 points (or $3,000). At this lower rate, their monthly payment drops to $998, or a savings of $51 per month.

By dividing the amount they paid for the points ($3,000) by the monthly savings ($51), we see that they will have to own the house for 59 months (or just under 5 years) before they will start to see savings as a result of paying points. If Bob and Betty plan to stay in the house for many years, then paying points could make good sense. But if they see themselves moving to another house in the near future, they'd be better off paying the higher interest and no points. (Note: for simplicity, the above example does not take into account the time value of money, which would slightly lengthen the break-even time.)

Can you deduct points on your income taxes?

In the United States, one side benefit of paying points on a mortgage loan is that they are fully tax deductible for the same tax year as your closing. However, this does not apply to points paid for a refinance loan. For refinances, the IRS requires you to spread out the deduction over the life of the loan. For example, if you paid $5,000 in points for a 30-year refinance loan, you can only deduct 1/30 of the $5,000 each year for 30 years. If you pay off the loan early, though, you can deduct the remaining amount that tax year.

Your Credit History

As part of the loan application process, virtually all lenders will want to see a copy of your credit report. The report will list all your long-term debts (credit cards, mortgage payments, automobile and student loans, etc), as well as your payment history. If you don't have a copy of your credit report, most lenders will generally require you to pay for a copy when they process your loan application.

However, most real estate experts agree that it is a good idea to obtain a copy of your credit report several months before you apply for a loan. This is so you have a chance to resolve any problems with your credit before your bank sees it. U.S. Federal law ensures that you have access to your credit report, which may be obtained from your local credit bureau or any of several national firms that specialize in credit reports.

Late payments

For most people, problems with their credit report are likely related to late payments on a debt. If you were late one month in paying off your credit card, but otherwise have a good payment history, chances are most lenders won't be too concerned. But if you have a history of late payments you'll need to document the reasons why. A slow payment history won't necessarily get you turned down for a loan, but you may have to pay a higher rate of interest or otherwise prove to the lender that you can repay your loan in a timely fashion.

Errors on your credit report

Many people are surprised to learn that credit reports can often contains errors or inaccurate information. If this is the case with your credit report, you'll need to contact the reporting agency or creditor to have the problem resolved. This can sometimes be a slow process, so make sure to give yourself time to clear up the mistake.

Bankruptcies and foreclosures

There's no getting around it, a bankruptcy on your credit report is not a good thing. But that doesn't mean you still can't obtain a loan. Even though a bankruptcy may stay on your credit report for seven to ten years, lenders will often consider the circumstances surrounding a bankruptcy (family illness, injury, etc.). Moreover, if you have reestablished good credit since the bankruptcy, a lender will be more inclined to approve your application.