A big part of buying a home is qualifying for your loan. Qualifying for your loan can seem like a hurdle in and of itself; new regulations are designed to make sure that you do not borrow more than you can afford to pay back, and banks, coming off of being shortchanged after the foreclosure crisis, are making sure that they are not loaning more than what the property is worth.
Let us assume you are lucky enough (or hard-working enough) to have the required income and required credit to get your loan approved. Your job is not done. Now you need to make sure that you actually understand your loan documents, specifically the kind of loan you have and how you will pay it back.
Fixed Rate Loans
There are generally two kinds of loans — Fixed and Adjustable Rate loans.
Fixed, as the name implies, means that whatever you owe with interest is divided equally over a term, usually 30 years, but some loans can be as short as 15 years. Your payment will remain the same assuming you make every payment on time. Many people like this loan because it locks the lender into an interest rate, and because the homeowner knows exactly what the payment will be.
Be aware that even if you get a fixed rate loan, if your property taxes are included (escrowed) in your payment, the payment may change if the property taxes owed go up or down. Also, fixed rate loans tend to require that you be able to show more income in order to qualify.
Adjustable Rate Loans
Adjustable rate loans, will change over time based on the interest rates that are applicable at any given time. This is much like gambling—if rates go lower, your payment will be lower, and thus you get the benefit of paying less interest and making a smaller payment. Of course, if the economy goes sour, and interest rates rise, your rate will go up.
Many loans do have a maximum interest rate, so even if something crazy were to happen to national interest rates, you would only pay the maximum annual percentage rate listed on your loan.
Many adjustable rate loans have an initial period, usually around three to five years, where the interest is fixed, and then will adjust based on the current market rates.
If you are getting an adjustable rate loan, you should not just ask yourself if you can pay the mortgage payment based on what the current interest rate is, but whether you could pay the interest in a “worst case scenario,” which would be the payment at the maximum interest rate possible.
Loans to Avoid
You always want to avoid interest only loans, where you make only interest payments, or any kind of loan with negative amortization, which means that the total amount you owe increases, even as you make payments. These are the kinds of loans that got people in trouble during the late 2000s.
Get help at every stage of buying or selling a home. Contact our real estate attorneys at The Law Office of Agnes Rybar LLC to help you with your real estate closing.