Pre-reading activity
Reassure students that the technical aspects of comparing
loan terms are not easy for anyone. Most home buyers do
not understand everything related to their loan. They learn
about the basics and then rely on experts they trust, such
as the mortgage lender and the real estate agent, to take
care of the details.
The purpose of this lesson is to teach some key concepts
so students will
feel less overwhelmed when they get to the final stage of
home buying. They should not worry if they don’t understand
everything completely.
Adjustable-rate mortgages (ARMs)
Look in your local newspaper for the weekly listing of loan
rates. You will probably see many kinds of ARMs. Rather
than confuse students with too many details, we have explained
only the basic concepts related to ARMs. Emphasize to students
that they should be very careful when considering an ARM,
since many attract buyers with low rates that go up considerably
later. The most important thing to learn about an ARM is
the maximum amount your payments might increase.
In looking at ads, you may run across the term “PITI.”
This stands for
principal, interest, taxes, and insurance. Often, all of
these are incorporated into one monthly mortgage payment.
Your students may ask you what it means to refinance a
loan. When interest rates go down, it is sometimes profitable
for borrowers to take out a new loan, with a lower interest
rate. They then use the proceeds of the new loan to pay
off the old loan, using the same property as security.
Extension activity
Ask students to take a poll of their family and friends
who are homeowners. How many have fixed-rate mortgages?
How many
have adjustable-rate mortgages?
Understanding points
You may want to give a few additional examples to illustrate
the concept of points. Call a local lender to get some realistic
examples. Or pick a fixed amount, such as a .02 percent
decrease in the interest rate for every point paid. Across
the board write zero points, one point, two points, and
so on, up to five points. If the loan is 10 percent with
no points, how much would it be with one point paid? (9.8
percent) With two points? (9.6 percent) And so on.
Locking in an interest rate
Give students some examples to help them see when it is
to their advantage to lock in an interest rate.
Example 1: Everyone is saying that the federal government
is going to raise interest rates soon in order to slow down
the economy. Right now the average interest rate for a 30-year
fixed-rate mortgage is 8 percent with
zero points. Should you lock in your interest rate?
Example 2: The interest rate on a 30-year fixed-rate mortgage
has just jumped from 8 percent to 8.5 percent. Many people
are saying this will not last and rates will fall. Should
you lock in the 8.5 percent interest rate?
Comparing APRs
Remind students that comparing APRs is the best way to measure
the true cost of a loan. However, the best APR is
not the only reason to choose a loan. The terms, the reputation
of the lender, and the availability of special loan programs
should all be examined.
Making a down payment
Making a down payment and paying closing costs are usually
the biggest hurdles low- and middle-income buyers face.
For this reason, most of the
special loan programs focus on ways to reduce the initial
amount buyers have to put down and spread it over the life
of the loan. The Looking
further section discusses these special programs.
Remind students that they shouldn’t make a down payment
so large that they do not have the funds needed for their
first few months in the new house.
There are some instances in which the seller will assist
the buyer with the down payment and closing costs. Ask a
real estate sales professional to give you some examples
of how you can sometimes negotiate with the seller of a
property to pay for some of your closing costs.
Comprehension check
Ask students to work individually to choose the best answer
and circle the letter. Then discuss the answers with the
class. Ask students to find the
passages in the text where the answers to each question
can be found.
Extension activity
Make up a set of 20 questions based on the information covered
in this lesson. Divide the students into two teams. Each
team takes a turn answering a question. For each question
it gets
correct, it receives a point. If it cannot answer a question,
the question goes to the other team. The team with more
points wins.
A note on hiring a real estate attorney
The need for an attorney may vary greatly depending on the
complexity of the sale. For a simple housing transaction,
a buyer may just ask the attorney to look over the purchase
and sales agreement and the documents to be signed at the
closing. In more complex situations, such as cases where
there is a dispute between the seller and the buyer over
who should pay repair costs, the attorney’s role could
be much greater.
Contacting your local housing agency
You may want to contact your local housing agency at this
point and invite it to send a speaker to your class. The
speaker might be able to discuss any special loan programs
the agency has for low- and moderate-income home buyers,
and home education counseling programs available to
potential buyers. The agency speaker may also be able to
address what to do if you encounter a problem during the
home-buying process.
Lesson 1: What you should know
about mortgage loans
Choosing the right kind of mortgage is
not easy. There are many kinds of mortgages and special
terms you can choose. In addition, if your income and savings
are not high enough to qualify for a typical loan, there
are a variety of special loan programs that you may be able
to take advantage of. This unit will give you some basic
information about choosing a mortgage loan.
Working with a mortgage lender
There are many types of loans. When you
walk into a lender’s office, the loan officer may ask
what type of loan you want. The loan officer will work with
you to determine how large a mortgage you can afford.
The lender determines how much you can
afford to pay for a home by asking several questions, including:
the sale price of the home you want
to buy,
the amount you are prepared to pay
as a down payment,
the amount of your annual income,
the amount of your debts, and
how much cash (savings) you have.
The loan officer will analyze this information.
Later, you will learn whether you qualify for the loan you
want.
Don’t be discouraged if you do not
qualify on the first try. Just as a shoe salesperson tries
a size larger or smaller, or suggests an inner sole to make
a better fit, a loan officer should try to see if your finances
can be rearranged so that you will find the loan that is
best for you.
Also, the kind of home you can afford
is greatly influenced by the type of loan product you use.
There are dozens of types of mortgage loans on the market.
You should ask your loan officer to explain the many options
that are available to you. You should also call several
lenders to compare rates and to see if they have any programs
you might qualify for. Remember, your mortgage is likely
to be the most significant financial decision you ever make.
So shop carefully!
Terms of mortgage loans
With your loan officer, you will have
to decide on the terms of the loan that best meets your
needs. Some important considerations include:
the length of time you have
to repay the loan (called the repayment term),
the type of mortgage,
the interest rate and points you pay,
the size of the down payment, and
the closing costs.
You
should consider the following questions when making a choice
of which loan is best for you.
1. How long a repayment term do I need?
Most people choose a 30-year mortgage
because it has the lowest monthly mortgage payments. The
money you actually borrow is called the principal.
The money the lender charges you to borrow the money is
called the interest. With payments over such
a long period, the principal is often less than the interest.
If you can afford higher monthly payments, a shorter repayment
term will allow you to pay much less total interest over
the life of the loan.
Even if you choose a 30-year repayment
term, you often can save a lot of interest over the life
of your loan by making extra payments ahead of schedule
when you can. There is usually a space on your monthly mortgage
payment coupon where you can write in an additional payment.
Check with your lender for more information.
2. What type of mortgage should I get?
Another important decision is the type
of mortgage to get. When you start shopping for a loan,
you’ll probably hear about a variety of mortgages.
It can get very confusing! Remember, most mortgages fall
into two basic types.
Fixed-rate mortgage. The
most common kind of mortgage is a 30-year fixed-rate mortgage.
It is also the easiest to qualify for. With a fixed-rate
mortgage, your interest rate stays the same over the entire
repayment term. This way, you know ahead of time exactly
what you will pay. These terms give you the best chance
to afford a house by keeping your monthly payments low.
Many people who are close to retirement age try to manage
the higher monthly payments of a 15-year fixed-rate mortgage.
That way they will own the house debt-free by the time they
retire.
Adjustable-rate mortgage.
Often called an ARM, this is a mortgage that has an interest
rate that moves up and down as the current interest rate
changes. ARMs usually offer a lower interest rate in the
beginning. Then, at certain times (usually once or twice
a year), the interest rate changes. There is a limit (called
a cap) to how much the interest rate can go up each year
and over the life of the loan.
An adjustable-rate mortgage is sometimes
chosen by people who plan to move in a few years. They aren’t
so concerned about rate increases years into the future.
People who believe their income will increase steadily over
the years may also chose an ARM.
There are also some special kinds of ARMs
offered through government programs to help low-income buyers
afford a home. Some ARMs also offer you a chance to convert
(change) to a fixed-rate mortgage later. The lender will,
however, charge a fee for the change. There are a wide variety
of ARMs, so be sure to choose carefully. Watch out for what
are called teasers. These are ARMs that “tease”
a buyer with very low interest rates in the beginning, but
then adjust to a higher rate after a short period.
3. How can I get the best interest
rate?
By paying points for a lower interest
rate. As you learned in Unit 1, interest rates change,
sometimes daily. Although the difference between an 8 percent
and an 8.25 percent interest rate may seem small, over 30
years it can add up to a lot of money! One way to get a
lower interest rate is to pay what are called points
(short for discount points). Points are a special fee you
can pay up front in order to get a better interest rate
from a lender.
A point is a unit of measure that equals
1 percent of the loan amount. So, if you take out a $50,000
loan, one point is equal to $500. For example, let’s
say a lender tells you he or she will charge you 9 percent
interest for a 30-year, $50,000 mortgage with no points.
You want to pay less interest. You ask the lender to quote
(tell) you what the interest rate would be if you paid points.
If you pay one point ($500) the lender lowers the rate to
8.8 percent. If you pay two points ($1,000), the lender
will lower the rate to 8.6 percent. You’ll need more
cash at closing to pay for these points, but if you plan
to live in your home for a long time, it may be worth it!
By “locking in” your interest
rate. While you shop for a loan, interest rates
can change. For this reason, it’s important to ask
if the mortgage lender will offer you a rate lock-in.
This guarantees you a specific rate, provided you close
the loan within a set period of time.
Locking in a good rate can save you thousands
of dollars if you are buying at a time when rates are going
up. If you are buying at a time when rates are going down,
you may want to wait until the last possible opportunity
before locking in.
By comparing annual percentage rates.
Comparing interest rates with different terms can be very
complicated. Some loans require points, and others don’t.
Some loans have many closing costs, while others have fewer.
The annual percentage rate
of the loan, referred to as the APR, builds in all these
costs and spreads them over the life of the loan. The APR
provides you with a way to compare the long-term cost of
different kinds of loans. When you call lenders, try to
make the calls on the same day so you have an accurate comparison
of their APRs, since interest rates may vary on a daily
basis.
4. How large a down payment will I
need to make?
In the past, many mortgage lenders expected
buyers to put down at least 20 percent of the price of the
house as a down payment. Today many lenders know this is
just not possible for most buyers, especially first-time
buyers. Sometimes you can put down as little as 5 percent
or 3 percent with special loan programs. There are even
some programs where no down payment is required! If you
pay less than 20 percent, you will probably be asked to
buy private mortgage insurance. This protects the lender
by insuring the loan if you cannot make your payments. The
cost of mortgage insurance is usually added to your monthly
mortgage payment.
5. How much will I have to pay for
closing costs?
There is still one more set of up-front
costs to keep in mind: closing costs. You
must pay various kinds of closing costs to transfer legal
ownership of the house from the seller to you. They usually
add up to between 3 percent and 6 percent of the purchase
price of the house. You’ll learn more about closings
in the next lesson.
You
should consider the following questions when making a choice
of which loan is best for you.