Home Loan Mechanics

Before you can be pre-approved for a mortgage, you’ll have to answer a whole lot of questions about the type of home loan you would like.

Here are the major variables you’ll want to consider when you’re comparison shopping:

• interest rates, including whether they are fixed or adjustable;
• points;
• amount of the loan;
• the amount of your down payment;
• closing costs;
• how much information you provide;
• the length of the loan; and
• whether there’s a balloon payment.

The interest rate you are quoted by a lender will have as much to do with your credit history as with the prime rate. Personal factors that influence the interest rate of a mortgage include:

• credit scores;
• the type of property (a single-family home, a mobile home, etc.);
• the amount of your down payment; and
• the size of the loan.

You also will be able to choose between an interest rate that is fixed and one that’s adjustable.

With a fixed rate mortgage, you know exactly what you are going to pay each month for the life of the loan. It’s the safest kind of home loan to have. If interest rates drop dramatically, you can always refinance to get a better rate; if interest rates go up, you’ll be smart for having locked in a lower rate.

With an adjustable rate mortgage (ARM), your monthly payments can change over time.

Most adjustable rate mortgages start out with a fixed rate that typically is lower than the going rate for an fixed-rate. Common ARMs have a fixed rate for one, three, five, seven or 10 years. After that, the interest rate will be adjusted each year.

When you’re shopping for mortgages, you’ll see adjustable loans listed as 1/1, 3/1, 5/1 and so on. The first number indicates how many years the initial fixed rate will last. The second number tells you how often the interest rate will be adjusted thereafter (virtually always a 1 to indicate an annual adjustment).

If you think you’re going to sell a house in five or seven years anyway, and you expect interest rates to rise, then you’re probably better off getting a 5/1 or 7/1 ARM. That’s because the initial interest rate likely will be lower than the rate for a 30-year fixed loan, and you’ll be selling the house before your interest rate changes.

In addition to the basic fixed or adjustable mortgage choices, there are some other options.

For example, a step-rate mortgage starts out with a fixed rate, usually for the first two years, then the interest rate rises.

And then there’s the interest rate buy-down plan. In this case, you can pay a fee to get a lower rate for a set period, usually two years. Then the interest rate rises to its normal fixed level.

Next: Amortization