In this series, the professionals at the B.O.L.D. Company will take you through the process of building a custom home in the Greater Cincinnati â€“ Northern Kentucky area. From plan and lot selection, to mortgage approval, to the actual construction, weâ€™ll take you behind-the-scenes each week for an inside look at a different part of the process.
This week, we look more closely at financing a new home purchase. There are many types and varieties of financing options, from paying cash, to obtaining private loans, to the myriad mortgage loan options. Because most people do not have access to that much cash, nor do they have friends or family with that much cash and the availability to loan it away, we are going to look at the most common mortgage loan options.
Mortgage loans come in several varieties, with the most commonly used being the fixed rate loan. Usually coming with 30-year or 15-year terms, fixed rate loans provide regular and predictable payments for which monthly finances can be budgeted. A rate is locked-in (“fixed”) and this same rate is charged for the life of the loan. The advantage is in being prepared and knowing what will be owed each month and for how long. The disadavantage is that if interest rates go down, you are still fixed at the same unchanging rate. (However, re-financing is still an option.) 30-year fixed rate loans allow for a lower monthly payment (because less principal is paid down each month), but because of the longer period of time, the total amount of interest paid is higher than with a shorter-term loan; furthermore, the interest rate is generally higher than for a shorter-term loan. 15-year fixed rate loans come with a higher monthly payment (because more principal is paid down each month), but less interest is paid over all, and they generally come with lower rates. Shorter-term loans also help you to build up equity faster and pay off the loan more quickly. Though less common, 40- and 50-year fixed rate mortgages are available; however, in these situations, while your monthly payment may be less, in the end, the result is often that you pay more in interest than the entire principal of the loan!
Adjustable rate mortgages (ARMs) became increasingly popular before the downturn, and improper use of this option is frequently blamed for the high number of foreclosures. Obtaining an ARM to get into more house than you can reasonably afford is one example of an improper use. Despite its recent bad reputation, used in a reasonable manner, ARMs can be useful. Adjustable rate mortgages are loans in which the rate is quite low for an initial period of time, whether it be one month or 5 years. After this initial term, the rate “floats”– or changes in relation to current market trends. It may change monthly or by some other term specified in the loan contract. Purchasers who do not intend to stay in their home longer than the initial low rate period may benefit from such a loan (assuming they are actually able to sell when expected). Similarly, if purchasers expect to have a better cash flow situation after the initial period (for instance, if they expect to have paid off student or vehicle loans, or expect to earn a higher income) ARMs may be manageable. Adjustable rate mortgages often come with payment caps, or limits on how high the monthly payment can go. While this sounds like a safety precaution, it can actually be a danger, in that if the interest rate becomes high enough that the monthly interest payment surpasses the cap, then the remaining interest due is added to the principal of the loan–so instead of paying down the loan, the loan actually increases in size over time. Very quickly, the principal of the loan becomes higher than the value of the home.
Convertible mortgage loans are adjustable rate mortgages that allow you to “fix” at a rate at some point during the life of the loan–thus, after the initial low interest rate, the ARM can be changed to a fixed rate loan (usually for a fee, often a sizeable one). Ideally, the terms would allow for the borrower to lock in a rate at any time, but be careful: some terms will only allow the borrower to lock in a rate during a narrow time period, and the mortgagee may or may not remind you when that time period arrives (and it is difficult to predict what the market rates will be at that time).
Interest only mortgages allow the borrower for the first few years to make payments covering only the interest, without paying down any of the principal. While this allows for lower monthly payments initially, no equity is built up during this time, and eventually, the payments will have to be increased to pay down principal. Using this option as a means of getting into more house than you can reasonably afford — like with ARMs — is, ultimately, not a beneficial use of this option.
Once you select a mortgage type, the next question is likely to be: what are discount points? Simply put, points are fees paid to the lender at
closing in exchange for a lower interest rate on the loan. The benefit to the lender is that they get more cash upfront, while the borrower has the advantage of paying less interest overall. If the borrower plans to stay in their home long enough to recoup the initial fees (often a considerable time period), and if the borrower has extra cash available to make the upfront payment, paying down points can be a good option. Furthermore, in negotiations between buyer and seller, the buyer sometimes pays points on behalf of the borrower, in order to get the sale without lowering the sale price (and thereby devaluing the home and the appraisals of those around it). Each point is equal to one percent of the total mortgage loan amount; thus one point on a $100,000 loan would be $1,000. How much change in the interest rate that this amount would purchase will depend on the terms of the loan, but it is typically about 1/8%. This, in turn, will allow you to determine how much interest you will save by paying points.
Each financing situation is unique, and only by examining each option, doing your homework, and asking questions will you be able to determine the best financing option for you.
The B.O.L.D. Company is uniquely situated to help you through each and every step of the custom home building process, from financing and design/selections to construction and warranty service. We are available to build on your lot in Northern Kentucky, or let our licensed real estate agents help you find the perfect home site! Our in-house drafting and design team, together with our on-staff licensed Professional Engineer, can help you find or design the plan of your dreams! And of course, B.O.L.D. combines quality products and craftsmanship with unsurpassed customer service, so that the finished home is everything you expect and more. Find out why 400+ other new home customers have trusted The B.O.L.D. Company since 1986!