Lender Comparison

Not all lenders are alike. Neither are their loans.

Shopping for a home loan takes real effort and research. Rather than choosing the first low interest rate that comes along in a Yellow Pages ad or web site, be sure to compare several lenders and explore all your options. The more you explore the more you save.

Fixed or Variable

Fixed-rate loans have one interest rate for the life of the loan, while variable rates can adjust within certain perimeters outlined in the loan. Most fixed-rate loans are 30-year, but 15-year, 20-year or 25-year fixed-rate loans are available, too. Generally speaking, fixed rate loans are the most predictable. Since your interest rate doesn�t change, neither do your monthly payments.

Variable rate loans, on the other hand, are less predictable. You may start out with a low interest rate and payment, because most Adjustable Rate Mortgages (ARMs) offer an initial rate that is generally 2-3 percent below a comparable fixed rate mortgage. Not only will your loan costs be lower; your purchasing power will be higher because you may be able to qualify for a bigger loan with an ARM. But after your initial period, your rate adjusts periodically which carries certain risk.

What's the Better Deal?

It depends. Interest rates can be unpredictable. Fixed rate loans are most attractive when interest rates are low. That's when most homebuyers will simply lock-in the current rate. When rates are high, more homebuyers purchase ARMs in order to keep their monthly payments lower for the first few years. Sound confusing? Don't be concerned, interest rates can go up and down but the rules of the game never change. Before picking a variable rate over a fixed-rate loan, you need to review the pros and cons of each, and then decide which type makes sense for your situation.

Decision Factors

First, ask yourself these questions in deciding whether to choose an ARM or a fixed interest rate loan:

How long do you plan to own?

If you plan on moving within five years, an ARM could save you money in the short term. On the other hand, if you plan to own it for longer and interest rates are currently reasonable, consider a fixed rate loan. It is more predictable.

What�s the Maximum Payment?

If you choose an ARM, how high can the monthly payment go? Ask yourself if you can pay that? Do you anticipate a raise? Are you willing to take that gamble?

Do You Foresee Other Debts?

Will you be taking on other sizable debts, such as a car or school tuition, in the near future? Although you can leverage a bigger home purchase now with an ARM, don't put yourself in a bind later. You could be facing larger home payments with less money left for other needs.

Compare the Types of Fixed and Variable Loans

When comparing fixed and variable types of loans, be sure to compare apples to apples. It is a common mistake to compare dissimilar loans. Fixed-rate and variable-rate loans have drastically different costs and payment structures. So you'll need to compare fixed rate loans with other fixed-rate loans, not with variable-rate loans. Let's review the types.

Fixed-rate Loan Plans "Old Reliable."

The 30-Year fixed-rate loan. With this loan, your payment stays the same for 30 years. That can be an advantage if you lock-in a good interest rate. But that 30-year term can be a disadvantage if interest rates go down.

"The Fast Payoff." The 15 or 20-Year Fixed-rate Loan.

As you pay you build what lenders call "equity," the financial ownership interest in your home. A 15- or 20-year loan allows you to pay off your loan balance faster, decrease your debt and increase your equity sooner. Interest rates on these loans are slightly lower than 30-year loans. And your total interest payment over the life of the loan is much less, too, up to 50% less on a 15-year loan. The disadvantages are: a) your monthly payment will be higher, so you must make more money to qualify for it; and b) you're locking away more money in home equity that could be invested elsewhere or spent on other needs.

Early Rewards

Many homeowners don�t realize they can reduce their interest payments on a 30-year mortgage just by paying it off early. (Of course, make sure there's no penalty for prepayment).

"Honeymoon Mortgage." The Graduated Payment Mortgage (GPM)

With this loan, monthly payments are lower during the early years, or the honeymoon period, because the lender is allowing you to pay off the loan principal later. You can qualify for a larger loan with this plan. After five years, the payments increase by a fixed percentage to catch up. Remember also that your loan balance, or principal, will actually go up in the first 10 years or so. That could be a problem if home values decline in your area.

Adjustable-rate Mortgage (ARM) Loan Plans

An ARM has certain basic features and optional choices that greatly affect your loan costs and future loan payments.

Basic Features

Index

The ARM Interest rate you pay is tied to a national index. The two most common are the T-Bill indexes: six-month, three-year or five-year treasury bonds, and the Cost of Funds Indexes (COFI). COFI loans are less volatile over time than loans based on T-Bills. A COFI loan is a safer loan, especially if rates are increasing. If you think rates will definitely go down, then you might consider a T-Bill loan.

Initial Interest Rate

Also called a "teaser rate," this rate only lasts until your first adjustment. Your lender may use this lower initial rate to determine how large a loan you qualify for.

Margin

Lenders add a few percentage points to the index rate, called the "margin." Your actual interest rate is the sum of the index rate plus the margin. The amount of the margin can differ from one lender to another, but it is usually constant over the life of the loan. In comparing ARMs, be sure to add the index and margin.

Adjustment Period

The interest rate and monthly payment will adjust periodically according to a fixed schedule. One-year ARMs adjust every year, while others change every three years, or five years. Example: On a 3/1 ARM, the initial rate lasts for 3 years and the interest rate adjusts annually.


Optional Features

Caps

An interest-rate or payment cap places a limit on the amount your interest rate or monthly payment can increase. Obviously, anything that provides protection against interest rate hikes is a very good idea, so pay close attention to the Cap. Although we've listed it here as an option, a cap is really a must. Avoid any ARM that does NOT have a Cap. Caps come in three versions:

1 - Periodic caps

These limit the interest-rate increase from one adjustment period to the next

2 - Overall Caps

These limit the interest-rate increase over the life of the loan

3 - Monthly payment Caps

These limit the total amount your monthly payment can increase from one adjustment period to the next.

Longer Term ARMs

You can limit your risk by choosing a longer term ARM, such as a 5/1 or 7/1, where the interest rate is fixed for five or seven years. The tradeoff is you'll probably pay a slightly higher rate than a typical ARM in exchange for that sense of security.

Balloon

These loans offer a lower rate during a set initial period, after which the rate "balloons" to a higher level. A balloon loan is only a good idea if you're absolutely sure you'll be selling your home or refinancing before the loan matures.

And how do you decide on the Loan that's right for you? Read on...

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