Homing in on mortgage best for you


A FEW years ago, my husband and I grew tired of living in a rundown apartment, where the patch of grass out front looked like the neighborhood dump. We plugged information about our incomes and savings into online mortgage calculators - a good place to start is Bankrate.com - to see how much banks would lend us to buy our own place.

Lenders are generous when they have a house or condominium as collateral, and even with a modest down payment, we could take out a much bigger mortgage than we could comfortably afford. We had to make a budget and decide on a price range and loan structure that fit our budget.

The largest hurdle for many first-time buyers is the down payment. The median down payment for first-time buyers last year was 6 percent on a $136,000 home, according to the National Association of Realtors.

Lenders offer many loan packages to help buyers avoid putting down large down payments and paying private mortgage insurance, also known as PMI. PMI protects the lender in case the borrower defaults and kicks in when a buyer puts down less than 20 percent. percent financing. With 100 percent financing, the lender offers two loans, one at market rate for 80 percent of the price and a second at a higher rate for 20 percent of the price. In both cases, the second loan is treated as a down payment, so borrowers do not have to pay the PMI.

Many lenders even offer 103 percent financing to people with excellent credit, which covers both the cost of the house and the closing costs.

Borrowing so much upfront has risks. Let's say your dream place costs $150,000 and you borrow 100 percent of the purchase price. If you have to move and housing prices fall 5 percent, then you can sell the house for only $142,500. You might have to give up an additional 6 percent to a real estate broker, which leaves you with $133,950. Somehow you've got to come up with $16,050 to pay off your lender.

My husband and I took out an 80-10-10 and quickly paid off the higher-interest second loan.

None of these packages should have prepayment penalties. For that reason, many lenders recommend taking them out for 30- rather than 15- or 10-year terms. The interest rate on shorter-term loans is slightly lower, but the higher payments can become a burden if you lose a job or have unanticipated expenses.

One way to gauge what you can afford is to make sure you can save the difference between your rent and the mortgage payments on your dream place, says Bank of America's Phil Greer.

Lenders also offer packages - which can be combined with the ones above - to help you reduce your monthly payments. Probably the most tantalizing are the interest-only loans. Despite the name, you do have to pay off the principal - starting after five or 10 years, when the monthly payments will jump. Also know that the rate will adjust as interest rates rise.

When my husband and I refinanced our loan last summer, we knew we would move soon so we got an adjustable-rate mortgage that locked in a low rate for three years.

The rate will adjust to the market rate if we don't move or refinance within three years. The shorter the term, the lower the rate. You can get one-, three-, five-, seven- and 10-year ARMs.

Mortgage brokers look out for themselves, warns Jack Guttentag, professor emeritus at the University of Pennsylvania's Wharton School of Business.

And shopping around for the right loan is difficult, not only because rates change daily but also because you often can lock in the terms only when you put money down.

Before going to a broker or directly to a lender, find out from a Web site such as Bankrate .com what the going rates are and from Guttentag's very useful Mortgage Professor site (www.mtgprofessor.com) which loan packages will work best for you.

E-mail Julie Claire Diop at yourmoney@tribune.com.

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