Advice Fact List

Advice: Housing & Mortgage

Continuing with our theme of financial advice, here is another one regarding Housing.

Types of Mortgages

Fixed rate mortgages

With a fixed rate mortgage the interest rate, and therefore the monthly payments (principal + interest), remain the same. Common fixed rate mortgage terms are 15, 20, and 30 years.

Longer terms equate to higher interest rates. While a shorter term means a lower rate, the monthly payments are higher to compensate. One strategy is to take out a 30-year mortgage at a higher interest rate, but to make extra payments to reduce the total amount of interest paid over the life of the mortgage.

 

Adjustable rate mortgages

Adjustable rate mortgages (ARMs) usually have a low initial fixed rate for a short time period before the rate is adjusted each year after the fixed period is over. For example, a 5/1 ARM is a mortgage that has a 5 year fixed rate period, and then adjusts annually.

ARMs offer significant risk, as the jump in monthly payments can be extreme depending on what the interest rate is tied to. ARMs may come with a wide range of options depending on the lender. Some have limits on how much the interest rate can increase during a given adjustment, some adjust with a different frequency than every year, and some offer longer fixed rate periods before adjusting.

ARMs can be particularly advantageous if a homebuyer plans to sell the property before the end of the fixed rate period.

Interest-only mortgages

With an interest-only mortgage a borrower only pays the interest due for a certain period of time, before starting principal + interest payments.

The obvious disadvantage of an interest-only mortgage is the borrower builds no equity in their property for the period they are only paying interest. When the interest-only period ends, monthly payments are necessarily higher than they otherwise would be because the borrower hasn’t been paying down the principal. Finally, most interest-only mortgages have an adjustable rate component to them.

Piggyback mortgages

In a piggyback mortgage a lender extends a traditional mortgage as well as what’s effectively an advance home equity line of credit – a second loan against the value of the property that the borrower also has to pay back.

This “piggyback” loan is usually at HELOC rates (higher than a normal mortgage) and has to be paid back concurrently with the traditional mortgage. The purpose of the piggyback loan is to reduce the cash required for a down payment on a property.

Isn’t renting just throwing away money every month? Or, What are the real costs of owning?

The main advantage to renting is that it requires much less capital and offers much greater flexibility if you want to change your housing situation. If the math works out in favor of owning (and it doesn’t always work out that way), these are the two features you’re paying for with your rent.

There are many factors to consider when evaluating whether owning might be more expensive than renting:

  1. Property Tax – if you itemize, this is deductible, but you’ll never see the money again. This is already factored into rent.
  2. Mortgage Interest – if you itemize, this is deductible, but you’ll never see the money again.
  3. Mortgage Principle/Home Equity – this is money that you are saving in your house instead of investing in the market. Home values have a different risk/return curve than equities, but not necessarily a better one.
  4. Utilities – Even if utilities aren’t included in rent, most people buy a larger home if they own than if they rent, so utilities can be higher. They are also higher per square foot for free-standing houses than for apartment buildings. Some apartment complexes also have reduced Cable and Internet prices, or better service. Renters also may not pay specifically for water, sewer, trash removal, and snow/lawn services.
  5. HOA fees may apply to owners.
  6. Maintenance – If you own, you pay to fix things instead of the landlord paying.

Obviously, home-ownership has many subjective benefits, and is not a purely financial decision.

What do mortgage lenders look for?

Potential lenders look at your housing expense-to-income ratio. Your mortgage payment as a percentage of your gross monthly income should generally be under 28%. Potential lenders also look at your total monthly payments relative to your gross monthly income. That calculation will factor in your other debts and must generally be under 36%. Finally, how much home you can afford will be largely based on the size of your down payment. Most lenders require at least 20% of the appraised value as a down payment to avoid private mortgage insurance (PMI) that adds to your monthly expense.

What are some additional costs when buying a house?

The list can be very long. But here are some. Closing costs, realtors commission, taxes, attorney fees, insurance, etc. Outside of these fees, just to get the mortgage approval you will need to pay for the inspection of the home, inspection of the water (if well on the property), and the pest/termite inspection. If you have issues with water, you will have to pay for it to be treated as well.

After that, there are the costs of any appliances and furniture that they don’t include (depends on seller) such as refrigerators, dishwasher, washer/dryer, etc. Then if there’s a yard you have to get the yard stuff as well. You will have to spend on landscaping, buying yard equipment (lawn mower, trimmer, etc.), ladder.  Then of course there’s the costs of anything you want to change such remodeling, paint, etc.

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  • Does ‘interest only’ work that way in the US? In the UK you have to pay back the principle at the end of the agreement not start making additional payments part way through… Also (and again this might be more relevant in the UK where house prices rise at a much faster rate than the US) do you really gain no equity in your home while only paying back the interest?

    “The obvious disadvantage of an interest-only mortgage is the borrower builds no equity in their property for the period they are only paying interest.”

    House prices are pretty much always on the increase here and so if (or rather when) your house price doubles you have gained equity as your loan to value ratio has dropped with the every increasing house prices. Personally I paid £295k for a house 12 years ago after borrowing £180k. I still owe the £180k but the property value is now about £800k. My loan to value has changed with the increase but also because inflation works in favour of people who hold property not cash that £180k at the time is equivalent to £269k now. By the time I need to repay it, the principle will be worth £80k to £120k in todays money. I have no intention of repaying it out of my own pocket at the end of the agreement. I intend to remortgage it with a tiny loan to value ratio which will keep getting smaller until it is insignificant and can be paid off with a small personal loan or remortgaged with a higher loan to value ratio allowing me to buy more properties.

    I have almost zero insight into the US housing market, but if it is anything like the housing markets in the rest of the world then this content of this article feels like an oversimplification.

    • In Canada we simply don’t have the range of options in the US and UK which is largely why we avoided any housing market decline (some vacation properties were depressed but not really losing value).

      The fact is that houses don’t ALWAYS go up. Was proven in our lifetime.

    • “I have almost zero insight into the US housing market, but if it is anything like the housing markets in the rest of the world then this content of this article feels like an oversimplification.”

      Well, to a degree it is over simplified, or at least that’s what a yank reader of it draws out. Not sure why it is skewed in such a way. The skewing may be helping keep the tone down to about I suppose what you lot would call grammar school level. Americans generally read at a level no higher than that as sad as that is to say.

      Me and the wife have looked into attaining help from the department of agriculture for housing. They offer a fixed rate mortgage at very low interest rate for the less financially able, it’s part of rural development stimulus to get people back toward homesteading. We faced and completed a requirement of a home ownership course, an eight hour crammed packed full informative “here’s what you sign on to do and get”. Turned out we knew most of it and fared better than we expected.

      A lot of that course was even skewed similar to this article. Seems even our government here has rather low expectations of us. I might be able to see that as sad if but for not knowing of our whole political system and the “fine” shape it is in. We’ve got what we deserve, as is said. No, it’s not sad when I see it like that. Instead it is infuriating that we as the people of our nation have been cowed into accepting it.

      Well mate, I apologize. Will digress as I think I might be missing the mark of what you were enlightening, even if not I cannot bear thinking on it too long. Big Brother tells me it’s all fine, so there’s that. 🙂 😉

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