from the author: (Please note, I'm a regular guy like everyone else, but have spent time researching this topic)
I was in a fortunate position that allowed me to purchase a home here in California around the San Francisco Bay Area. Here is some terminology that you'll encounter in your search for home loans. I've also included some hints that I've learned in the process. Hopefully they'll be helpful for you.
- 30 Year Fixed Interest and Principal
This is the most traditional type of home loan. It has a higher interest rate and is fixed for 30 years. The risk is that the interest rate you get may not be the lowest interest rate you can get during your 30 years with the loan. You might see the rates drop even further and you'll be stuck with your current rate.
- 5/1 ARM Interest and Principal
When you hear about a 5/1 ARM Interest and Principal type of loan, it means that you're paying a mortgage principle interest that is fixed for 5 years. If found this type of loan to be a safer loan than the 5/1 ARM Interest Only because you're also reducing your principle owed each month. You have more of a negative amortization. This means your loan amount isn't increasing over time, or that it's not increasing as fast as other loans because of the interest payments. Most lenders will still increase your interest rate after your 5 year term is over, but it's easier to deal with compared to other loans because you can refinance to a lower rate beforehand and you're mortgage principle owned has been slowly paid down.
- 30 Year Fixed Interest Only
A 30 Year Fixed Interest Only means you need only pay interest. You can pay back the principle on your own timing. However, most loans of this type include a recalculation clause during the 10th year. If you haven't paid any principle back, you could be in a lot of trouble with a steep increase in your monthly interest payments. A lot of home owners default in their 11th year because they can't pay the increased interest payments, most likely because they haven't paid much down in their principle. Typically, the interest rates for 30 Year Fixed Interest Only Loans are higher than those of the 5/1 ARM Loans.
- 5/1 ARM Interest Only -
With this home loan you pay only the interest for the first 5 years. The interest rate will be fixed during this time. You can also pay a little extra each month to lower your principle owed. After the 5 year term is over, your interest rate will adjust according to what the current Federal interest rates are. Thus the name "Adjustable Rate Mortage" or ARM. Typically these new rates increase from your starting teaser rates, and your monthly payments will increase. If you haven't been paying down your principle while taking care of the monthly interest payments your first 5 years, you'll be owing a lot more in payments after the initial term is over. So while you may have low monthly payments compared to the other loan types out there, you may find yourself in trouble if you're not careful with your finances during your first 5 year term.
Note also that I decided to pay for 1 extra points for the 5/1 ARM Interest Only loan, which means I have to pay an extra 1% during loan closing which reduces the monthly payment by a few hundred dollars which will be recouped after 19 months. I also plan to pay extra every month for the principal as well as set up a plan to pay twice a month because this would reduce the 30 year loan to like maybe 22 years(more about this below).
Lessons I learned
One of the things I have learned about mortgages is that I can actually decrease the length of a 30 year loan to about 22 or 23 years. I've read several books, among them was a book by David Bach entitled, "The Automatic Millionaire Homeowner." It's really quite simple. Let me share.
Instead of making the monthly payments the way we normally do it, we split it down into half and pay one-half every other week. Say our loan payment was $2,000 per month. Under the biweekly plan, instead of sending a $2,000 check to our lender once every month, we would send them a $1,000 check every two weeks. At the beginning, paying $1,000 every two weeks probably won't feel any much different than paying $2,000 once a month. But remember the calendar isn't as straight forward as it seems. A month after all, is a little more than four weeks.
What happens as a result of moving to a biweekly payment plan is that over the course of a year we gradually get further and further ahead of our payments, until by the end of the year we have paid about 13 months worth of payments instead of 12. The change is gradual but significant in the long run.
A monthly mortgage payment of $2,000 amounts to $24,000 a year. When we make an extra half payment every 6 months we end up with 26 1/2 payments which is equivalent to $26,000. So with this recalculated monthly payment plan we've moved ourselves up $2,000 in payment. This allows us to pay back our loan faster, saving ourselves from the dreaded interest that incurs through time. We can end up paying off a 30-year mortgage early. Calculated it would be between 5 and 7 years early with about $106,000 of savings if the interest rate was at 7%.
You should know that some lenders cannot service all types of loan applications that come to them. For example, you might want a loan from XYZ company. XYZ company might be broker or a direct lender. A couple things could happen if they cannot service your loan, either XYZ company goes to a direct lender like CountryWideHomeLoans since CountryWideMortgages which is the largest home loan lender in the United States, or sometimes XYZ company is a small company and is part of a lending network like LendingTree, in this case it might be better to go with LendingTree to see if LendingTree can create a competition between its lenders so that you save a bunch of money when the deal comes to you. As LendingTree would put it, when Lenders compete you win.
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