Find The Home Loan that Fits Your Needs

By: G. M. Filisko

Published: February 10, 2010

Understand which mortgage loan is best for you so your budget is not stretched too thin.

The basics of mortgage financing
The most important features of your mortgage loan are its term and interest rate. Mortgages typically come in 15-, 20-, 30- or 40-year lengths. The longer the term, the lower your monthly payment. However, the tradeoff for a lower payment is that the longer the life of your loan, the more interest you’ll pay.

Mortgage interest rates generally come in two flavors: fixed and adjustable. A fixed rate allows you to lock in your interest rate for the entire mortgage term. That’s attractive if you’re risk-averse, on a fixed income, or when interest rates are low.

The risks and rewards of ARMs
An adjustable-rate mortgage does just what its name implies: Its interest rate adjusts at a future date listed in the loan documents. It moves up and down according to a particular financial market index, such as Treasury bills. A 3/1 ARM will have the same interest rate for three years and then adjust every year after that; likewise a 5/1 ARM remains unchanged until the five-year mark. Typically, ARMs include a cap on how much the interest rate can increase, such as 3% at each adjustment, or 5% over the life of the loan.

Why agree to such uncertainty? ARMs can be a good choice if you expect your income to grow significantly in the coming years. The interest rate on some—but not all—ARMs can even drop if the benchmark to which they’re tied also dips. ARMs also often offer a lower interest rate than fixed-rate mortgages during the first few years of the mortgage, which means big savings for you—even if there’s only a half-point difference.

But if rates go up, your ARM payment will jump dramatically, so before you choose an ARM, answer these questions:

How much can my monthly payments increase at each adjustment?
How soon and how often can increases occur?
Can I afford the maximum increase permitted?
Do I expect my income to increase or decrease?
Am I paying down my loan balance each month, or is it staying the same or even increasing?
Do I plan to own the home for longer than the initial low-interest-rate period, or do I plan to sell before the rate adjusts?
Will I have to pay a penalty if I refinance into a lower-rate mortgage or sell my house?
What’s my goal in buying this property? Am I considering a riskier mortgage to buy a more expensive house than I can realistically afford?
Consider a government-backed mortgage loan
If you’ve saved less than the ideal downpayment of 20%, or your credit score isn’t high enough for you to qualify for a fixed-rate or ARM with a conventional lender, consider a government-backed loan from the Federal Housing Administration or Department of Veterans Affairs.

FHA offers adjustable and fixed-rate loans at reduced interest rates and with as little as 3.5% down and VA offers no-money-down loans. FHA and VA also let you use cash gifts from family members.

Before you decide on any mortgage, remember that slight variations in interest rates, loan amounts, and terms can significantly affect your monthly payment. To determine how much your monthly payment will be with various terms and loan amounts, try REALTOR.com’s online mortgage calculators.

More from HouseLogic
Evaluate Your Adjustable Rate Mortgage

Show Your Support for FHA

Other web resources
How much home can you afford?

Why ask for an FHA loan?

G.M. Filisko is an attorney and award-winning writer who’s opted for both fixed and adjustable-rate mortgages. A frequent contributor to many national publications including Bankrate.com, REALTOR® Magazine, and the American Bar Association Journal, she specializes in real estate, business, personal finance, and legal topics.

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How FICO Credit Scores Work

By:

Published: October 14, 2010

Buying a house, refinancing it, getting a loan, getting a job—they’re all dependent on your FICO credit score. It pays to learn how it’s calculated.

How are FICO credit scores computed?

FICO uses five broad categories to calculate credit scores, and each category is weighted accordingly:

Payment History 35%
Amounts owed 30%
Length of credit history 15%
New credit 10%
Types of credit in use (is it a “healthy” mix?) 10%

Why are there three FICO credit scores?

There are three main bureaus that collect data on your credit history: Equifax, Experian, and TransUnion. FICO takes data from each credit bureau and runs it through its system. This leads to three different FICO credit scores because:

  • Each agency may have information one or both of the others don’t have. For example, a collection agency may have reported a bad debt to only one of them.
  • Errors that occur just in one agency’s data may affect that agency’s results, but not the results from the other two.

And to make it even more complex, many lenders augment their credit decisions by adding particular criteria they want to consider.

Also, although FICO is the best-known credit score, there are many others. Some lenders generate their own credit scores using data from the same three credit bureaus. Experian, in fact, has developed its own scoring system separate from FICO.

However, FICO remains the most common; when big lenders refer to your credit scores, they’re usually referring to the FICO scores.

Why can a credit check by itself reduce a FICO credit score?

FICO’s research shows that more credit shopping, resulting in more inquiries, correlates with a higher risk of future default. However, multiple queries in a short period for one purpose—such as when you’re shopping for a HELOC—would count as only one inquiry.

The FICO score ignores any mortgage, student loan, or auto loan inquiries made within the previous 30 days. The system limits itself to inquiries made in the 11 months before that, and reduces similar inquires within any 45-day window to a single inquiry. For example, if you approach five banks over two weeks on a HELOC, it will only count as one inquiry.

The inquiry formulas can get rather complex; the FICO site has more details.

How long does major negative information stay on my credit report?

Generally, the impact of adverse information on a FICO score lessens over time.

Foreclosures 7 years, with rebound beginning in as little as 2 years.
Deeds in lieuand short sales 7 years—they usually appear on credit reports as foreclosures.
Late payments 7 years. It doesn’t matter what the late payments are for. Recent late payments hit your credit score harder than older ones, and the amount and frequency of the late payments are also factors.
Bankruptcies 7 years (10 years for “full discharge of debt”—i.e., if you’re absolved of your full debt, the bankruptcy stays on your credit report for 10 years). Because they often involve more than one account, bankruptcies generally have a greater negative impact on your credit score compared with a foreclosure, short sale, or deed in lieu.

How does loan modification affect my FICO credit score?

Until November 2009, if you were in a loan modification program, your credit report likely notes that you have made only a partial payment. This significantly lowered your FICO score.

However, in modifications made since November 2009, the credit reporting system was changed to reduce the credit score hit. But as of October 2010 FICO hadn’t completely bought into this system and may at some point decide that everyone in a loan modification program, whether under new or old rules, deserves a significantly lower score.

For now, your best bet is to obtain your free credit reports, as noted later in this article, and see how your particular situation was reported and handled.

Do reductions in credit card or HELOC limits affect my credit score?

The impact will be unique for each consumer. The FICO formula considers many aspects of your balances and behaviors, including whether you have a high percentage of available credit at the time the report was pulled.

For example, if you have high debt and use a substantial proportion of your available credit, you’re at a greater risk. Opening a new credit card to increase available credit, after another card was reduced, may backfire and reduce your credit score.

Do lenders have to tell me if they’re basing a quote on my bad credit score?

New regulations taking effect in 2011 require lenders to tell you if they’re giving you a particularly high interest rate or other less favorable loan term than other borrowers who qualify for the best deals. In the past, the lenders may not have told you that you were getting an especially high rate—you were penalized without knowing it.

Starting in January, you’ll be forewarned.

Then if your credit score is lower than you expected, you can investigate it—maybe it’s just an outdated report or a simple mix-up. At least you’ll know the deal before signing on the dotted line.

But don’t wait until you apply for a loan to discover your credit is a mess. By law, you can get a free report from each agency once a year at Annualcreditreport.com. (And no, this isn’t the company advertising with the slacker band on TV.) This is the only site authorized by the Federal Trade Commission to provide free reports.

However, these reports don’t include your FICO scores. You can purchase TransUnion and Equifax FICO scores from MyFico.com for $15.95 each. (Experian continues to provide a FICO score to lenders but no longer sells its score on a retail basis.)  Some consumers will qualify for free FICO scores starting in mid-2011 or early 2012.

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