Picking the parts of the package

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Nailing Down the Details before you lock

Erin Condit

A former foreign correspondent for many newspapers, Erin Condit has also worked for written a biography on Haiti’s Duvalier family, and is a former vice president of Merrill Lynch & Co.

It was perfect. A three-acre parcel overlooking the Columbia River, surrounded by award-winning wineries and vineyards. The 49-year-old former ad buyer could already picture herself in the house of her dreams, watching the sunset over the striking landscape, a glass of vintage wine swirling in her palm. And why not? Shannon Bright had always made her clients’ dreams come true. Now it was her turn.

"It’s hard not to be overwhelmed by the sheer number of mortgage products out there, but the good news is help is easy to find."

"I want it to be mine," she sighed.

But how? With the dizzying array of mortgage types she saw online, figuring out which one was best for her was tougher than she thought. Should she go with a fixed or variable rate loan, and if she chose a variable rate, which index would it be tied to: MTA, COFI, LIBOR, or Bank Prime Rates? Should she pay points to decrease her monthly payments? Should she go with a Balloon Mortgage, 100% Financing, or one of the many different flavors of ARMs and Option ARMs? Would she qualify for an FHA loan?

It’s easy to get lost in the acronym soup of mortgage research, but the good news is that help is easy to find. These days, the web is full of sites like Mortgage.com to give you all the definitions you could possibly need to find the right mortgage product for you. Still, it’s hard not to become overwhelmed by the sheer number of mortgage products out there. How do you choose? In some ways, your very first step—giving yourself a thorough financial checkup—is your best guide throughout the entire process. Knowing your financial goals—and limitations—is critical to understanding why some products are better than others.

Once Sharon Bright got past her initial sticker shock and decided that this was indeed her ideal home, her next big decision was to select a mortgage product. A 30 year fixed loan offered the stability of the same rate and payment throughout the term of the loan, but the monthly payments were higher on than some other types of loans. . Was there another way to push her monthly payments down? With an 7/1 Interest Only (I/O) ARM, Sharon would make no payments on the principal of her loan for the first seven years, after which the loan would reset to another rate based upon an index—in this case, a Treasury bond. There were both up- and downsides to this product. Sharon’s salary was based on commissions, so she decided she needed a loan with maximum flexibility. Since there were no prepayment penalties on this loan, any extra money she saved could be used to pay down the principal early. And because interest on an I/O loan accrues on a monthly basis, (just multiply the interest rate by the loan amount and divide by 12), with every month Sharon paid more than her monthly balance, her additional payments would be used to pay down the principal balance of her loan.

But there was risk here too. Sharon had no intention of moving from her new home—ever. If Sharon did not pay more than her monthly payment, at the end of the interest-only period: she would still owe the original amount borrowed, and her monthly payment would increase, even if interest rates stayed the same, because she would have to pay back the principal as well as interest. If interest rates kept creeping up, by the time her seventh year rolled around, her interest rate and monthly payment could increase beyond her comfort range. If her initial interest rate was less than a fully indexed rate, her interest rate and monthly payment could increase even if interest rates went down! She could of course refinance before then into a 30 year fixed or even another ARM, but then she would not only have to pay into an economy with rising interest rates, she’d have to pay another round of fees. And Sharon was loathe to do that. As a newly minted entrepreneur, she was having enough trouble making the downpayment on this purchase. Her loan officer at the local bank said she could qualify for a Federal Housing Administration mortgage with just 3 percent down but she would have to pay FHA’s form of PMI (Mortgage Insurance Premium). Sharon looked harder at her finances: In the end, she was able to come up with 5 percent for the downpayment resulting in a lower mortgage insurance premium—and a comfortable way for her to afford the home she wanted. There were still a lot more questions to ask, but for now the future was looking pretty good for Sharon Bright.