Grasp of loan basics aids borrowers

Feb. 12, 2006

Grasp of loan basics aids borrowers

ARA CONTENT

With all of the different types of home loans available, it's no wonder home buyers can get confused. However, mortgage experts say every home loan is one of two types: fixed rate or adjustable rate. Before shopping for a home, consumers should understand both types. Following are some basics:

Fixed-rate loans

With most fixed-rate mortgages, the monthly principal and interest payment will not change for the term of the loan, regardless of whether interest rates rise or fall.

In exchange for that stability, the borrower may have a higher interest rate than he would with an adjustable-rate loan. Fixed-rate loans are available with different length terms and, usually, the longer the term, the lower the monthly principal and interest payment.

Adjustable-rate loans

Many people who choose adjustable-rate mortgages also qualify for fixed-rate loans. However, the lower initial interest rate of adjustable-rate mortgages, and the opportunity to take advantage of lower monthly principal and interest payments, have made homeownership more accessible to more people.

With most adjustable-rate mortgages, the interest rate is fixed for a set period of time and then begins to adjust for the rest of the loan's term.

Getting the right loan

People looking for a home tend to focus on finding one before they consider what kind of mortgage to get. That could be a mistake, according to Tony Meola, an executive at Washington Mutual.

"Many people look at the mortgage as secondary in the home-buying process, when that's really where they should start. A mortgage professional can tell home buyers how much home they can afford before they start shopping."

He also pointed out that the amount of money a buyer needs to put down on a home is one of the most misunderstood concepts in home buying.

"Some people think they need to make a down payment of 50 percent of the home's price. But most loans are based on a 20 percent down payment."

Check the amortization schedule (how long it will take to own the home). This schedule shows exactly how much of each payment goes towards interest and how much goes towards principal.

Affordability is another factor. With a fixed-rate loan, the principal and interest payment never changes. With an adjustable-rate loan, the borrower should ask himself if will be able to afford the payments in the future.

Finally, some loans offer attractive monthly payments, but sometimes those low payments don't cover the interest portion of the loan.

When that happens, part of the principal amount is deducted, resulting in negative amortization. Simply put, it means the borrower is losing equity in the home.

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