| There's good debt and bad
debt. Mortgages are definitely the good kind of
debt. Why? Because real estate usually appreciates
(gets higher in value). You can buy a house and,
just five years later, it's value can go up 100,000!
The other very cool bonus is that you can deduct the
interest you pay from your taxes! Let's say you
make $60,000 a year and you pay $10,000 in interest on
your home loan... You get to subtract that $10,000
and just pay taxes on $50,000!
A house or condo will probably be
the biggest purchase of your life... So, let's
talk about the basics of how you'll do the financing.
There are two main types of
mortgage loans:
Conventional Mortgage Loans:
These are
funding by banks, savings and loans. The property
you are buying is the collateral for the loan -- i.e. If
you don't make the payments, the bank gets your house.
Government Backed Mortgage Loans: These are
still funding by banks, but the government insures the
loan. The two main types are VA (Veteran's
Administration) and FHA (Federal Housing
Administration). About 20% of all mortgages are
government backed. Only certain people qualify for
these loans. But there are advantages... The
interest rate is lower, they require a lower down
payment and it's easier to qualify (you don't need to
make as much money).
So, once you pick one of these
main types, there are other important decisions to be
made. Really, there are two big decisions:
1)
You have to decide how you want the interest rate to
work.
Fixed-Rate Mortgage Loan:
This loan is
locked into a specific interest rate -- whatever the
current mortgage rate is. So, for the entire life
of the loan, you'll be paying, say, 5.75% a year in interest.
This is what most people do and, in general, it's the
smartest and safest way to go.
Adjustable-Rate Mortgage Loan:
This loan
starts out really low (for anywhere from the first three
months to as long as 7 years), then can go up or down
depending on what's happening with interest rates.
This loan is a gamble. If you buy when interest
rates are low, they'll probably go up... They
could go up so high that you might not be able to afford
the payments. If you buy when rates are high, this
might be a good deal since it's a good bet that your
rate will go down. If rates are low and you're
only planning on owning the house for a few years, this
could be a smart move. Really, there's a LOT more
to it, but this is the basic idea.
2)
You have to decide how long of a loan you want to take.
30-Year
Term Mortgage Loan: This is what most
people do, because the payments are lower. Yeah,
it will take you 30 long years to pay off your house,
but many people live in their houses that long and, if
you don't, the loan just gets paid off when you sell the
house.
15-Year Term
Mortgage Loan:
With this loan, you pay it off in just 15 years...
But, your payments will be higher even though you always
get a lower interest rate with the 15-year loan.
You save money in the long run because you are paying it
off a lot faster.
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Let's look at
some real examples... I'll use some real interest
rate numbers for the day I wrote this (June 2005-2009): Borrow
$200,000 at a 30-year,
fixed rate of 5.471% (a
year)... Your monthly payment will be
$1131.94... And the
total cost will be $407,499.00.
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What if it was a
15-year loan?
Borrow $200,000 at a
15-year, fixed rate of
5.471%... Your
monthly payment will be $1631.09
(a lot more). BUT, the rates on 15-year
loans are always less... Let's crunch that at
5.091%... Your
monthly payment will be $1591.08
which is still a lot more... BUT, the total cost
will only be $286,395.16...
So, overall, you save $121,103.84
and that's a CHUNK!
What about one of those
30-year adjustable rate
mortgage loans?
Borrow $200,000...
You might start out with an interest rate of just
3.638%... Your
monthly payment will be just
$913.57 which is a LOT less. BUT, what if
that rate goes up?
At 7%, your monthly payment
will be $1330.60.
At 10%, your monthly
payment will be a whopping
$1755.14! Ouch.
(There are caps on how much your rate can go up and they
only change it once a year, but still, it can really get
you!)
Two other details and the first
is really important:
1)
Make sure you won't
get penalized for paying your mortgage off early!!
Making extra payments is a great thing because you'll
save on that total cost. Some loans will charge
you a penalty for this, so be careful.
2)
Some mortgage loan are
what's called "assumable." This means that, if
someone buys your house, they don't have to get their
own loan, they can just use yours. Not all loan
are like this and it's really not something most do, but
there is an advantage. Say you bought your house
when rates were low (like 5.5%) and you need to sell
your house when rates are much higher (say 11%).
It's hard to sell a house when the rates are high,
because people's payments will be a lot more. BUT,
if you can just transfer your nice, low rate to them, it
makes the purchase a lot more attractive. Just
something to think about.
As for the down payment, always
put down as much as possible!
Also, when figuring out how
much of a monthly payment you can afford, keep in mind
that you'll have to pay for yearly property taxes
(usually 1% of the price, but sometimes up to 3%) and home owners insurance.
And, if you don't put 20% down, you'll have to pay PMI
(private mortgage insurance). Overall, even
without the PMI, you should figure that the additional
costs of home ownership will be about 45% of your
monthly mortgage payment.
Here's the last thing...
Pay a little extra (on the
principal) each month and pay your mortgage off early!!
Why?
Because THE
BEST DEBT IS NO DEBT!
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