Wednesday, June 8, 2005

 

Financing your first home

For many first-time homebuyers, the biggest hurdle is saving up the down payment. In today's high-priced real estate markets, 20 percent of the purchase price can amount to a significant chunk of change. But don't give up. Even if you've got a down payment of just three percent or even less, there are lots of ways you can buy a home. Here's what they are and how they work.

• Mortgage insurance. By getting a loan with mortgage insurance, you can lock in the lowest fixed-rate first mortgage that's available and you'll know exactly what your payments will be. Private mortgage insurance enables lenders to make loans covering more than 80 percent of a property's value, which are statistically riskier. The advantage is that it's predictable and stable-if interest rates rise, you won't feel it. Also, you can cancel it as soon as your equity builds to 20 percent. The potential disadvantage may be a slightly higher monthly payment than you'd get with a different financing structure.

• Piggyback loan. An adjustable-rate second mortgage "piggybacked" on a fixed-rate first mortgage is called a piggyback loan or an 80-10-10 (80 percent first, 10 percent second and 10 percent down payment). Lenders like piggybacks because they make commissions on both loans and borrowers like them because the initial payment may be somewhat lower than a loan with mortgage insurance. Potential disadvantages include paying origination fees on two loans instead of one and carrying a greater debt load. Also, when interest rates rise, you'll see higher payments on adjustable-rate second loans.

• Interest-only loan. These loans allow borrowers to make "interest-only" payments during a defined period, usually five to ten years, so your initial payment may be lower. At the end of that time, however, payments increase significantly. Interest-only borrowers are especially vulnerable to rising rates-and could face potentially much larger payments due each month as interest rates increase. By paying interest-only, and no principal, borrowers are not building equity in their home.

"Piggyback and interest-only loans became popular because interest rates were low," explained Steve Smith, President of PMI Mortgage Insurance Co., the nation's second largest provider of private MI. "But the prime rate has increased eight times since June 30, 2004 and probably will again. If you have a second mortgage with an adjustable rate or a loan with a balloon payment you'll need to refinance, you could be looking at a challenge." Doug Long, CEO of Pinnacle Financial, one of the nation's fastest growing independently-owned mortgage lenders, recommends mortgage insurance for most first-time homebuyers. "Homebuyers with mortgage insurance build equity in their homes at a faster pace than borrowers using other loan structures. When their homes appreciate, homeowners build greater equity and consequently can cancel mortgage insurance sooner-resulting in even greater savings," he explained.

The bottom line? Choose the product that's right for you. Calculate what the options will cost, not only now but when interest rates rise. And consider what will best protect you if you do have trouble.

"No one buys a house intending to default but sometimes bad things happen to good people," Pinnacle's Long said. "So what I tell borrowers is that the choice is not just about the initial payment. It's about finding the product that will best protect their dream of homeownership."