How to Shop for a Mortgage:

With dozens of competing lenders and mortgages to choose from, you may think that today's home loan market is terribly confusing. It really isn't though if you know the basic facts about financing a house. That's what this brochure is designed to give you. Let's start with the questions that are probably uppermost in your mind.

How Large A Mortgage Can I Get?
That depends upon your income and the cost of your new house. Lenders use certain guidelines to determine the mortgage amount that they will lend any one homebuyer. The two guidelines used are housing expenses and long term debt. Lenders generally say that housing expenses (including mortgage payments, insurance, taxes and special assessments) should not exceed 28 percent to 33 percent of the homeowner's gross monthly income. For Federal Housing Administration (FHA) loans, this figure is not to exceed 29 percent of the homebuyer's gross monthly income. With loan guaranteed by the Department of Veteran's Affairs (VA), lenders measure prospective homebuyers with "Residual Income," or the monthly income minus expenses. The remainder is then measured against geographical and family size data to qualify the borrower.

FHA Loans

Housing expenses = 29% of gross monthly income
Housing Expenses Plus Long-Term Debt = 41% of gross monthly income

VA Loans

Housing Expenses Plus Long-Term Debt = 41% of gross monthly income
Residual Income = Varies by location and family size

Conventional Loans

Housing Expenses = 28% - 33% of gross monthly income
Housing Expenses Plus Long-Term Debt = 36% - 42% of gross monthly income

Lenders usually define long-term debt as monthly expenses extending more than 10 months into the future.

What Types Of Loans Are Available
Although you may see many different types advertised, they all belong to just two families: those mortgages that carry fixed interest rates, and those whose rates change during the course of the loan on a periodic schedule mutually agreed upon by you and your lender - Adjustable Rate Mortgages (ARM's).

Fixed Rate Mortgages
You are probably familiar with a fixed-rate mortgage. Your parents more than likely had one, as did their patent before them. The major advantage of fixed rate mortgages is that they present predictable housing costs for the life of the loan. Some fixed-rate mortgages you will probably hear about are:

• 10-year fixed-rate mortgages
• 15-year fixed-rate mortgages
• 20-year fixed-rate mortgages
• 25-year fixed-rate mortgages
• 30-year fixed-rate mortgages

When people thought of a mortgage 10 to 50 years ago, they thought of a 30-year fixed-rate mortgage. This traditional favorite is not the only choice nowadays because volatile financial times created a whole new range of selections. However, the 30-year fixed-rate mortgage may still be the best mortgage for your circumstances. It offers the lowest monthly payments of fixed-rate loans, while providing for a never- changing monthly payment schedule. Some lenders offers 25,20, and even 40-year term mortgages as well. But remember, the longer the term of the loan, the more total interest you will pay.

The 15-year fixed-rate mortgage allows homeowners to own their homes free and clear in half the time and for less than half the total interest costs of the traditional 30-year loan. Some homebuyers prefer this mortgage because it allows them to own their home before their children start college. Others prefer it because they will own their home free and clear before retirement and probable declines in income.

The major disadvantages of the 15-year fixed-rate mortgage are the higher monthly payments. But if saving on total interest costs and cutting the time to free and clear ownership are important to you, the 15-year fixed-rate mortgage is a good option. The bi-weekly mortgage shortens the 30 year loan term to 20 to 24 years by requiring a payment for half the monthly amount every two weeks. The bi-weekly payments increase the annual amount paid by about 8 percent and in effect pay 13 monthly payments (26 bi-weekly payments) per year. The shortened loan term decreases the total interest costs substantially. The interest costs for the bi-weekly mortgage are decreased even further, however, by the application of each payment to the principal upon which the interest is calculated every 14 days. By nibbling away at the principal faster, the homeowner saves additional interest. Remember, however, that you trade lower total interest costs for fewer mortgage interest deductions on your federal income tax. Your ability to qualify for this type of loan is based on a 30-year term, and most lenders who offer this mortgage will allow the homebuyer to convert to a more traditional 30-year loan without penalty. Availability is limited on this mortgage, but it can be worth looking for.

Mortgages That Change
Some newer mortgages afford homebuyers some of the best qualities of the fixed-rate and adjustable rate mortgages.These mortgages, gives homeowners the predictability of a fixed- rate and adjustable rate mortgage for a certain time, most often seven or 10 years, and then the interest rate is adjusted to fit market conditions at that time. The main advantage associated with this type of loan is that homebuyers often get a lower than market rate to begin with. The main disadvantage is that they may see their interest rate go substantially at the end of the initial period. The lender may also reserve the option to call the loan due with 30 days notice at that time, making this loan similar to a balloon mortgage in some cases.

Lenders offer this type of loan in part because research indicates that many homebuyers remain in the home for only 5 to 10 years before moving. For this type of homebuyer, this loan presents an excellent way of getting a fixed- rate loan at a better than market price for a fixed, but shorter period of time. However, these loans are always amortized over 30 years, which means the lowest possible payment.

Another type of mortgage that is becoming popular is called a Lender Buydown, where the homebuyer gets an initially discounted rate and gradually increases to an agreed-upon fixed rate over a matter of three years. For example: When the market rate is 10 percent, the fixed rate for the mortgage is set at about 10.5 percent, but the homebuyer makes monthly payments based on a first year rate of 8.5 percent. The second year the rate goes up to 9.5 percent, and for the third year through the remaining life of the loan, the rate is calculated at 10.5 percent. A second type of lender buy-down, called a Compressed Buydown, works the same way, but with the interest rate changing every six months instead of on a yearly basis.

The Lender Buydown gives consumers the advantage of lower initial monthly payments for the first two years of the loan when extra money may be needed for qualifying purposes and, secondly, the advantage of knowing that, although the interest rate does change during the first three years of the loan, the interest is fixed from the third year on.

Convertible Adjustable Rate Mortgages (ARMs) are another new loan product on today's market. It works like any other ARM, but it offers homeowners a distinct advantage - it allows them to turn their ARM into a fixed-rate mortgage after a set period.

A new product developed by the Federal National Mortgage Association (Fannie Mae), which buys mortgages from lenders, allows the homeowner to convert an ARM to either a 15 or 30 year fixed-rate mortgage for a small fee of approximately $250, as compared to the costs of refinancing. Say, for instance, that you got your convertible ARM at an initial interest rate of 10.0 percent, and after a year or so, rates had dropped to 8.0 percent. For the smaller conversion fee, you could adjust your mortgage to either a 15 or 30 year fixed-rate loan at a new rate that would be about one-half percent higher than the going market rate, or 8.5 percent. There are other variations on this loan available from lenders across the country. Homebuyers who want the low initial rate of an ARM, and the option and peace of mind of a fixed mortgage should rates drop, can now have it both ways.

Adjustable Rate Mortgages
Adjustable Rate Mortgages (ARMs) have become on of the most popular and effective tools for helping some prospective homebuyers achieve their dream of homeownership. Developed during a time of high interest rates that kept many people out of the housing market, the ARM offers lower initial rates by sharing the future risk of higher rates between borrower and lender.

ARMs can be an excellent choice of financing under certain conditions, such as rising income expectations, high interest rates, and short-term homeownership. But because payments and interest rates can increase, either steadily or irregularly, homebuyers considering this kind of mortgage need to have the income to keep up with all possible rate and/or payment changes. Each ARM has four basic components:

Initial interest rate, which is typically one to three percentage points lower than that of most fixed-rate mortgages. Lower interest rates also make ARMs somewhat easier to qualify for. The initial interest rate is tied to certain economic indicators that dictate in part what the monthly payments will be.

Adjustment interval, which is the time between changes in the interest rate and/or monthly payment will be.

Index, against which lenders add the "margin" to establish the payment interest rate payable at each adjustment interval. The most popular index is based on the rate of return on a one- year Treasury bill (also called T-bill).

Margin, or the additional amount the lender adds to the index to establish the adjusted interest rate on an ARM. The margin is usually 2.0 percent to 3.0 percent.

In addition to the four basic components, an ARM usually contains certain consumer safeguards such as interest rate caps, which limit the amount that the interest rate applied to the payments may move. This prevents the amount of interest the consumer pays from rising higher than perhaps the homeowner can afford. For instance, a typical ARM would have a 2% cap over the life of the loan. That means that a loan with an initial interest rate of 6.00 percent would be able to go no higher than 12.00 percent over the life of the loan, and it would be able to move no more than two percent per year.

Another safeguard found on some ARMs are monthly payment caps that limit the amount homeowners need to increase their payments at adjustment time. Monthly payment caps can, however, sometimes prevent the monthly payments from increasing enough to keep up with the rise in the interest rate, causing negative amortization-resulting in higher or more payments for the homeowner later on.

FHA/VA MortgagesThe Federal Housing Administration (FHA) and the Veterans Administration (VA) offer a wide range of mortgage choices that may appeal to you. These include 30 and 15 year fixed- rate mortgages, as well as ARMs. Insured by these government agencies, the loans feature low or no down payment terms and are often assumable by future purchasers. VA loans are restricted to individuals qualified by military service or other entitlements, but FHA - insured loans are open to all qualified home purchasers. Talk to your lender about FHA/VA possibilities.

Creative Financing or Seller-Assisted Mortgages
Seller-assisted creative financing usually means the seller of the home helps with the financing by holding a second mortgage for part of the total loan required to purchase the home.

One problem you are apt to run into with seller financing is the balloon payment mortgage. Balloons, as they are known, are usually offered as short-term fixed-rate loans. The balloon payment mortgage gets its name from the payment schedule, which involves smaller payments for a certain period of time and one large payment for the entire amount of the outstanding principal. They have terms of 3, 5, and sometimes 15 years, though payments are usually calculated as though it were a 30 year loan. The major disadvantage with a balloon payment loan is that it may be difficult to save up the money to make the final large payment (often the entire amount of the principal) while paying interest on the loan. Some lenders guarantee refinancing, though the interest rate is usually adjusted when the principal comes due. If you cannot refinance, you may lose the property if you cannot meet the large payment. Balloons are an advantage if you plan on living in an appreciating house for a short period of time and want to pay less while you live there.

How Do You Shop Most Effectively For A Mortgage?
There are several ways. First, talk with your buyer broker. It is part of his/her job to help you obtain the best financing opportunities in the marketplace. Lenders regularly call agents to alert them to financing packages. And, of course, agents are highly motivated to obtain financing for their buyers. Without a suitable loan, the sale can't proceed, and agents won't get their sales commission on the house.

Second, look for rate surveys published by your local newspaper. Many American papers now include brief tables on interest rates and mortgage availability in their real estate or business section. They can help guide you to sources you have not thought about.

Third, look in the Yellow Pages under "Mortgages," and shop for quotes by telephone. Call 3 to 5 different lenders for rates and terms on fixed and adjustable loans.

How Do We Evaluate Different Loans?
One important method is by bearing in mind that mortgage packages consist of more than interest rates. They consist of a quoted rate, plus discount points (pre-paid interest assessed by the lender at settlement, or the meeting when the property legally changes hands) and other fees, plus a full range of terms including adjustable versus fixed-rates, low down payment versus high down payment, the presence or absence of prepayment penalties, and many other features noted earlier in this brochure.

One way to evaluate rates, however, is by examining the Annual Percentage Rate (APR). The APR can help you compare different types of mortgages. It indicates the "effective rate of interest" paid per year. The figure includes discount points and other charges and spreads them out over the life of the loan. While the APR provides you with a common point for comparison, look at the whole product before deciding which mortgage to get. Pick the one with the rate, payment schedule and other terms hat suit your situation best.

Terms You Should Know

Acceleration Clause

If you miss a monthly payment, an acceleration clause allows the lender to speed up the rate at which your loan comes due or even to demand immediate payment of the entire outstanding balance of the loan.

Assumability

Assuming a mortgage is simply taking the loan over from the holder (seller) and becoming liable for the repayment.

Buydown

The buydown mortgage is one where the seller and/or the home builder subsidizes the mortgage by lowering the interest rate during the first few years of the loan. While the lower initial payment and interest rate make this kind of loan easier to qualify, the payments may increase when the subsidy expires.

Closing Costs/Settlement Costs/Escrow

Closing costs ate the costs associated with settlement, the meeting where the buyer and seller (or their agents) sit down to fill out the papers and make the exchanges that allow the property to legally change hands. Closing costs include appraisal fees, title search and insurance, survey, tax adjustments, deed recording fees, credit report and points, among others.

Due-on Sale Clause

A clause or provision in a mortgage or deed of trust that allows the lender to demand immediate payment of the balance of the mortgage at the time of sale.

Negative Amortization

This occurs when your monthly payments are not large enough to pay all the interest due on the loan. This unpaid interest is added to unpaid balance of the loan. The danger of negative amortization is that the homebuyer could end up owing more than the original amount of the loan.

Private Mortgage Insurance

In the event that you do not have a 20 percent down payment, lenders will allow a smaller down payment-as low as 5 percent in some cases. With the smaller down payment loans, however, borrowers are usually required to carry private mortgage insurance.

Private mortgage insurance will require additional premium payment of 0.5 percent to 1.0 percent of your mortgage amount plus an additional monthly fee depending on your loan's structure. On a $75,000 house with a 10 percent down payment, this would mean an initial premium payment of $338 to $675 and an extra $15 to $20 a month.