The highs and lows of parenting and real estate.

Mortgage Lesson

I have read, recently, several articles with scary headlines like, “With Market Hot, Buyers Embrace Risky Mortgages” and ” Top cities for risky, interest-only mortgages” about this fairly new phenomenon of interest-only mortgages. I have to admit, that I did not totally understand the theory behind these types of mortgages. I had a fairly solid understanding of a 30-year or a 15-year fixed mortgage, but these bizarre interest-only creatures with ‘arms’ left me mystified, and the news reports kept me terrified.

This was until last week. Last week I took a mortgage class at my real estate office. It’s a class that’s given monthly, and it just happened that this month only two of us chose to attend it (and the other guy there had already been through it once), so I pretty much got to ask all of the questions I’d ever had about mortgages.

My questions:

1. What are these ‘interest-only’ mortgages and why would anyone want them?

Answer: The interest-only mortgage refers to the Adjustable Rate Mortgage (ARM). This type of mortgage is usually a 5 year ARM or 7 year ARM. It basically means that you take out a 30 year mortgage with a fixed interest for the first 5 or 7 years. In a 30 year fixed mortgage you have an interest rate that is fixed over the life of the loan, however, the amount of interest paid in each payment changes. In the beginning, the payments you are making are mostly toward the interest portion of your loan, and there is very little paid toward the principle. As time goes on, your payment stays level, but the amount you’re paying toward interest goes down and the amount toward principle goes up. In an ARM, for the first chunk of time (5 or 7 years) you only have to pay interest, which would be lower than if you had a 30 year, but then after that period, the interest rate can change (go up or down as the market has fluctuated) and your payment will then be fixed, like it is with a 30 year, with you initially paying more toward interest. The benefit is, that if you had a 7 year ARM and paid the same amount of money a month as you would owe in a 30 year fixed, more of that payment would go toward principle and by the time you got to your regular fixed time, you would have a much smaller loan to be dealing with. The problem is when people take out these loans and only pay the minimum amount they are required and possibly end up owing more than the house is worth.

2. What’s the deal with the 80-20 100% financing and PMI?

Answer: I have written before about the evils of PMI and the fabulous shoe-buying power of not having it. In the last year or so, I keep hearing about people getting financing for 100% of their loan, but doing it in two chunks (an 80% loan and a 20% loan) so that they do not have to pay PMI. So I asked our loan guy if this actually works and why I hadn’t done it in the first place to avoid those annoying extra payments. His answer was basically that YES, it absolutely does work and there really aren’t any draw-backs. He said that doing smart things like this with your mortgage is the advantage of having a knowledgeable loan agent and being well-informed from the beginning. Lesson learned here: do your homework!

3. I have heard that having your credit pulled can actually put a small ding in your credit report. So if I apply for a loan pre-approval and you pull my credit, will it do harm to my credit score? What if I want to shop around, will I get dinged with every loan officer I try?

Answer: Having your credit pull will minutely affect your credit score. It is unfortunately a necessary evil. The good news is, the way it is set up, you can have your credit pulled as many times as you want within 14 days and it will only register as one pull. So if you plan on shopping around, get it done in two weeks and it will not be an issue.

So that was the meat of what I learned. I came away with a little more confidence in the mortgage game, I hope you feel the same way.

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