Homing In on Your First Mortgage Part 2

What Kind of Mortgage Should I Get?

Mortgage loans fall into two basic categories: fixed rate and adjustable rate. With a fixed-rate mortgage, the interest rate—and thus your monthly payment—stays the same throughout the loan. Adjustable-rate mortgages (ARMs), on the other hand, change periodically and are tied to an index such as the interest rate on a one-year Treasury bill.

Which is better? Determine how long you're going to stay in the house and realize that the shorter the time, the more an adjustable rate makes sense. Beware of getting caught in the ARM trap which saw millions thrown out of their houses in the foreclosure crisis though. Read the fine print and make sure you can still afford the ARM when the rates go up!

Here's why: ARMs usually offer an initial "teaser rate" that's lower than any other mortgage on the market. If you know you'll be moving again in three or four years, your average interest rate, even with yearly upward adjustments, will probably be lower than you could have gotten with a fixed-rate mortgage. However, if you end up staying and the rates skyrocket, then get used to either living on KD or living on the streets. Many thousands of homeowners before you didn’t believe they could end up in either situation and that’s where they find themselves today!

Other considerations:

Go with an ARM if you want a house at the upper limit of what you can afford. In my first home I didn't qualify for a fixed-rate mortgage of 10 percent, the going rate when I bought, because payments would have exceeded 28 percent of my income; the monthly payments on a mortgage of $150,000 would have been $1,317. But I did qualify for an ARM at 8.75 percent. At this rate, my monthly payments were $1,180.50.

Opt for a fixed rate if the thought of future payments going up has you reaching for the Maalox. Most first-timers choose a fixed rate because they want predictability. If interest rates are low, lock them in with a fixed rate.

What About Points and Closing Costs?

A "point" is 1 percent of a loan amount; the "points" you owe at closing are a fee paid to your lender as part of your mortgage deal. The lower the interest rate, the more points you'll usually have to pay at closing. For example, many banks recently offered fixed-rate mortgages of 3.25 percent, while the national average was around 4 percent. The difference? The lower-rate loans generally required an up-front payment of about two points, or 2 percent of the loan amount, at closing — remember, that's in addition to the down payment. Points aren't all you'll have to pay at closing, of course. Attorney's fees, homeowner's insurance, document fees, and other miscellaneous charges will also be due. A general rule is to set aside a minimum of 3 percent of total house price for these costs.

Should I Get a Pre-Approved Mortgage?

Absolutely. Buyers with an approved mortgage in hand assure the seller that their offer is serious.

Even if home sales are sluggish in your area, don't shrug off the idea of pre-approval. When buyers are scarce, sellers may not want to take their home off the market for six weeks or more while waiting to see if a bidder's loan is approved.

Will Home Ownership Affect My Taxes?

Yes, and very, very favorably. Buying a home is one of the two biggest ways to lower your taxable income. Points, interest, and real estate taxes are all deductible in the USA, and the savings can be substantial. If, for example, you have an 8 percent mortgage for $150,000, are in the 28 percent tax bracket, and pay $250 a month in property tax, you'll lop about $5,800 off your tax bill.

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nicomp 6 years ago from Ohio, USA

My opinion is that if one must carry debt, deductible debt is preferable. No debt whatsoever is optimal, but at least the government will give us back some of our money by permitting us to not pay taxes on interest paid.

For example, paying the lender $100 means that we don't pay taxes on that $100, which takes $28 (28 per cent tax bracket) off our tax bill. But we still don't have the original $100 anymore. On the other hand, if we didn't have the interest payment, we would keep the $100 and pay the $28 in taxes, which leaves us with $72 to buy groceries. It's a shell game at the federal level.

By the way, not all mortgage interest is tax-deductible. Mortgage holders eventually reach a point where the default deduction allowed on the 1040 form exceeds the amount paid in interest; it's advantageous to take the default deduction and face the fact that your mortgage interest ain't payin' no more.

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