It isnt just the value of the house you buy that determines the value of your investment; it is also the terms in your mortgage loan. A loan that may look tempting because of initial low payments could turn out to be more expensive than the traditional 30-year fixed rate instrument, if the cost of the money to buy the property is skewed to increasingly higher interest rates as the loan matures. For example, some adjustable-rate mortgages can cost up to 50 percent more when the loan resets, after the initial teaser period where monthly payments are traditionally lower than the thirty-year fixed-rate mortgage.
The greater percentage of a monthly mortgage payment that credits the loan interest at the expense of the principal has hidden costs. This is particularly true of interest-only mortgages. While the initial 5-10 year payments cover only the cost of the loan, the time it takes to build real equity in the home by paying on the principal of the loan (amount borrowed) remains at zero. Therefore, if a rainy day comes, and you need to borrow money on the value of your house you have no established value to draw on, since the payments have been credited to the interest, and not the principal. If the housing market is in a bit of a slump at the time you choose to borrow against the equity you think you have in it, you could be in a position of owing more on the house than it is currently worth.
Another mortgage that can be tricky to value is the Option Payment ARM Mortgages. Under the terms of these loans, you have the option to pay a minimum amount monthly that doesnt fully cover the cost (interest) of the money you have borrowed to make the purchase. Not only will this arrangement cause the loan to extend over a longer period of time, thus costing you more overall, the interest payments themselves will cost more, if you calculate the additional time you are buying each time you choose not to make a full monthly mortgage payment.
There are also 40-year mortgages available to some who are challenged by the affordability of homes in our area. While the monthly payments are likely to be less than a thirty-year fixed-rate mortgage, the loan overall is more costly because it will take you longer to pay it off, thus earning greater interest for the mortgage company.
While adjustable-rate mortgages are sometimes a smart option for buyers who expect to be in a home less than five years, it is usually better to select a fixed-rate on a mortgage, if you expect to be in the house longer than that. The cause of failures of some high-risk mortgage companies recently is due to a high willingness to take on too much risk.
The same applies to the homebuyer. Sticking to a budget, selecting a loan instrument with which you can quickly build equity in your home, and watch for opportunities to refinance, should rates drop lower than the original loan, are usually better options for most homebuyers than taking on risky repayment terms. If the mortgage seems too good to be true, it probably is too good to be true.
Take the time to shop around for a mortgage. Most lending institutions have one or two well-priced loan programs they advocate, because they make up the difference on the volume of loans they can sell under these terms. Find the one with the package best suited to your finances. Many first-time buyers are afraid to shop around because they fear it might hurt their credit rating. Not so. When buying a home or a car, you can have multiple dings on your credit history during a 30-day period, and it will only count as one. Dialing for dollars can take on a whole new meaning, if properly executed.
Jeni Upchurch provides a weekly update on the real estate market. Her real estate practice includes all of northern Virginia and the District of Columbia. She is affiliated with McEnearney Associates old town, Alexandria office. She can be reached directly at 571-216-6701 for a consultation.
