Before
you commit to buy a Charlotte Lake Norman home you need to study the loan
process. We have several articles regarding home financing and how
become an educated buy regarding purchasing a home.
Lake Norman Real Estate -
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.
Lake Norman Real Estate - 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 though 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. FHA loans are insured to the actual lender and VA
loans are guaranteed 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.
Lake Norman Real Estate - 15-Year, 30-Year, or a
Biweekly Mortgage?
In the past, the 30-year,
fixed-rate mortgage was the standard choice for most homebuyers. Today,
however, lenders offer a wide array of loan types in varying
lengths--including 15, 20, 30 and even 40-year mortgages.
Deciding what length is best
for you should be based on several factors including: your purchasing power,
your anticipated future income and how disciplined you want to be about
paying off the mortgage.
What are the benefits of
a shorter loan term?
Some homeowners choose fixed-rate loans that are less than 30 years in
order to save money by paying less interest over the life of the loan. For
example, a $100,000 loan at 8 percent interest comes with a monthly payment
of around $734 (excluding taxes and homeowner's insurance). Over 30 years,
this adds up to $264,240. In other words, over the life of the loan you
would pay a whopping $164,240 just in interest.
With a 15-year loan,
however, the monthly payments on the same loan would be approximately
$956--for a total of $172,080. The monthly payments are more than $200 more
than they would be for a 30-year mortgage, but over the life of the loan you
would save more than $92,000.
What are the advantages
to a 30-year loan?
Despite the interest savings of a 15-year loan, they're not for everyone.
For one thing, the higher monthly payment might not allow some homeowners to
qualify for a house they could otherwise afford with the lower payments of a
30-year mortgage. The lower monthly payment can also provide a greater sense
of security in the event your future earning power might decrease.
Furthermore, with a little
bit of financial discipline, there are a variety of methods that can help
you pay off a 30-year loan faster with only a moderately higher monthly
payment. One such choice is the biweekly mortgage payment plan, which is now
offered by many lenders for both new and existing loans.
Biweekly mortgages
As the name implies, biweekly mortgage payments are made every two weeks
instead of once a month--which over a year works out to the equivalent of
making one extra monthly payment (compared to a traditional payment plan).
One extra payment a year may not sound like much, but it can really add up
over time. In fact, switching from a traditional payment plan to a biweekly
mortgage can actually shorten the term of a 30-year loan by several years
and save you thousands in interest.
If you're interested in a
biweekly payment plan, make sure to check with your lender. In many cases,
lenders also offer direct payment services that automatically withdraw funds
from your bank account, saving you the trouble of having to write and mail a
check every two weeks.
Making extra payments
yourself--do it early!
Another way to pay off your loan more quickly is to simply include extra
funds with your monthly payment. Most lenders will allow you to make extra
payments towards the principal balance of your loan without penalty. This is
especially attractive to homebuyers who are concerned about their future
earning power, but still want to be aggressive about paying off their loan.
For example, if you had a
30-year loan, you might decide to send the equivalent of one or two extra
payments a year (which could shorten the overall length of the loan by many
years). But if your financial situation suddenly took a turn for the worse,
you could always fall back on the regular monthly payment.
One important note, though,
is that if you do decide to send extra funds, make sure to do it EARLY in
the life of the loan. This is because most home loans are calculated in such
a way that the first few years of payments are almost entirely interest,
while the last few years are mostly applied towards the principal balance.
Thus, you can get the most bang for your buck by making the extra payments
early in the life of the loan.
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After becoming an
educated borrower, call us to find you the Charlotte Lake Norman home of
your dream.
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