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Step 2: Loan Programs

In order to avoid spending more money than necessary when purchasing a home, the buyer needs to understand the ways in which different loan programs work and choose the one which fits their situation the best. Factors which influence the loan programs include the relationship between interest rate and points and the length of time that the buyer intends to own the home.

Lenders often have a variety of programs to choose from. Each program may also have multiple combinations of interest rates and points. For instance, a financial institution may give the home buyer a choice of the following:

Program	Interest Rate	Points
30 Year Fixed	8.00%	1.25
	7.25%	2.00
15 Year Fixed	7.25%	1.00
	7.00%	0.75
1 Year Adjustable	5.75%	1.00
7/23 Year Adjustable	6.50%	1.00
30 Year Fixed FHA	8.50%	0.00

Do you see the connection between the interest rates and the corresponding points? If you want to pay less points, you are going to pay a higher interest rate and vice versa. Often first time home buyers are in the situation where they do not have the extra money to pay many points. In this case, they may opt for a higher interest rate.

Another reason why a buyer may choose a higher interest rate with lower points is if they are not planning on owning the house for more than a couple of years. The reason being that paying points lowers the interest rate on the loan. A lower interest rate means lower monthly payments. Over time, the savings from the these lower monthly payments will pay for the extra points paid at closing. In most cases, it will take several years for the points on a loan to pay for itself. If a buyer sells the house within 5 years, the buyer could be losing part of the points that were paid up-front (in which case the buyer would be better off paying the higher interest rate).

An alternative to opting for a higher interest rate with low points if the buyer is planning on selling in a couple of years is selecting an adjustable rate mortgage (ARM). If the buyer is unsure of how long he will be committed to the mortgage, he may consider an ARM that is fixed for the first five or seven years.

Below is a list of the different loan programs and a description of how each works.

15 & 30 Year Fixed Conventional
Mortgage payments(principal & interest) are the same for the life of the loan. The loan is not insured by the Federal Housing Authority (FHA) or guaranteed by the Veterans Administration (VA). Private Mortgage Insurance (PMI) is required by the lender if the buyer's down payment is less than 20 percent.

FHA Loan*
Loan which is insured by the Federal Housing Administration (Limits on loan amount vary between counties, call local lender for loan limits).

VA Loan*
Loan which is guaranteed by the Veterans Administration (Borrower must be a veteran of U.S. Armed Services) *FHA and VA loans are backed by Government Agencies and insure the lender against borrower default. Since these loans usually require little or no down payment (0% - VA loans, 3-5% - FHA loans), they make housing available to buyers that could normally not afford a substantial down payment.

Balloon Programs: 5,7,10 year Balloon
Loan which payments are calculated based on a fixed rate schedule (usually a 30 year fixed rate program) and paid monthly for a specified term (5,7,10 years). At the end of the term, balance must be paid in full ("balloon payment") immediately.

5/25 & 7/23 (2-step) Balloon
Programs that have the option (at the end of their term) to convert to a fixed rate program for the remainder of the loan's life.

Adjustable Rate Programs: Adjustable Rate Mortgage        
(ARM)** Programs that offer a lower interest rate than fixed rate loans (for the beginning period of the loan). The interest rate on the loan remains fixed for a set period of time. Once this period is reached, the interest rate will be adjusted, based on a selected economic index (eg. T-bill rates, cost of funds) for another set period of time. This process repeats itself throughout the life of the loan. ** There are multiple varieties of Adjustable Rate Mortgages.

Graduated Payment Mortgage (GPM)
Loan in which payments are smaller at the beginning of the loan. Payments rise on a fixed schedule or a predetermined number of years. (usually 5, but sometimes 10) The first few years of payments are applied to interest payment only. Due to the fact that the loan principal balance can actually increase under this program, negative amortization may occur. It is recommended that buyers consult their lenders if considering this program.

Growing Equity Mortgage (GEM)
Mortgage in which each year's payments are increased by a predetermined percentage (typically 7.5%). This increase is applied directly to the repayment of the principal of the loan.

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