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Not Recommended Loans
for First-Time Homebuyers

Here Is A List Of Mortgages That Are Probably Not Safe For First-Time Homebuyers:

1 month, 6 month, 1-year, 2 year, and 3 year fixed loans. - Any loan with a fixed period of less than five years is risky for a first-time homebuyer. If the homebuyers stays in the property longer than the fixed period, they may have to refinance or sell the property if market interest rates have gone up a lot during the time that their interest rate was fixed. At the end of the fixed period, the loan's interest rate will immediately adjust to whatever the current market rate is. There are a number of two and three year fixed loans that are just starting to adjust right now and some of these home owners are in trouble. Refinancing is not an option for many of these people because interest rates have gone up too much. Many of these people are now kicking themselves for not taking a 30 year fixed when the rates were so low a few years ago.

Subprime Loans - Some people get into these loans because the loan officer convinced them that two or three years would be enough time to clean up bad credit and refinance into a better loan. People with poor credit can often take out loans known as "subprime" loans. These loans usually have a short fixed period of two or three years. That is dangerous. What if the credit isn't cleaned up in two years? A possible foreclosure situation has been created. When subprime loans go adjustable after the fixed period ends, they tend to adjust to very high rates. There are a lot of predatory lenders  in the world of subprime that are only concerned about their commission right now and not what happens to the homebuyer a few years down the road. Just for the record, at the time of this writing more than 4% of all subprime borrowers are more than 60 days late in their payments. I do not do subprime loans because they are dangerous for borrowers. I strongly believe that a person should get their credit in order before buying their first home. I am very willing and able to assist a person with credit issues in order to get things straightened out. I am not in the business of making mortgage loans that will put homeowners at risk of losing their homes in the future if everything doesn't work out exactly as they planned. If I believe that a loan might be risky for a borrower, I will advise them of the risk that I see. I have never had borrower go into foreclosure and I am proud of that record. In case you are interested, Click Here to get an unusual ( and perhaps scary) look at what the subprime lending industry has done to itself by lending money that it should not have.

Option ARMs. - These are sometimes called Pick-a-Payment loans or Neg Ams. First-time buyers should absolutely steer away from these. Option ARMs are the fastest way to lose all the equity in your home. Option ARMs typically have four payment options that the borrower can choose each month. The minimum payment option is the reason that people get into these loans. Selecting the minimum payment option will cause rapid "negative amortization" to occur. Instead of paying down your mortgage balance, it will now be increasing, sometimes at a rate of over $1,000 per month. Why would you want that? Almost everyone  that I have ever seen get into an Option ARM was doing their best to get out of it within a year.

Variable Rate 2nd Mortgages - 2nd mortgage can have a fixed rate or a variable rate. 2nd mortgages with variable rates usually use the Prime Rate as the base right. In a period of about two years, the Prime Rate jumped from 4.00% to over 8.00%. Borrowers with variable-rate 2nd mortgages experienced large, steady increases in the monthly mortgage payments. Rates are still historically low. The Prime Rate could rise further. Borrowers who take out variable rate 2nd mortgages should take into consideration that the payment on their 2nd mortgage will increase every time the Fed raises rates. Variable rate 2nd mortgages are known as Home Equity Lines of Credit, or HELOCs. You are probably better off with a Home Equity Loan, known as a HELOAN.

Stated Income Loans - The amount of money that mortgage lenders will lend to a homebuyer is determined by a calculation called "Debt Ratio." Quite simply, your debt ratio is the sum of all of your monthly debts (car payments, minimum credit card payments, student loans, installment loans, personal loans plus the anticipated housing expenses of mortgage payment, property tax, and insurance and/or HOA) over your gross (before tax) monthly salary. Mortgage lenders will lend you money up to the point where the mortgage payment causes the debt ratio to reach a certain number. Usually that number is 45%. At that point, if you wanted to borrower more money, your debts would have to lower or your income would have to be higher.

Lenders like to see that the income stated on the loan application is fully documented with paystubs, W2s, 1099s, etc. A loan in which the income is fully documented is called a "Full Document" loan. If a homebuyer would like to borrower more money than he could if his income was fully documented, that homebuyer will have to use a "Stated Income" loan. In this case, the homeowner states more income on the loan application than he can document in order to make debt ratio work out for a higher loan amount. A very dangerous situation can be created if a loan officer allows a borrower to significantly overstate income in order to buy a much more expensive home. It has been documented that when actual debt ratios exceed 50%, the likelihood of foreclosure is greatly increased. Will the loan officer or Realtor get hurt if you foreclose in two years? No. Will you? Yes. Be wary of doing Stated Income loans. You should not buy a home that you can't afford. The 45% industry standard debt ratio has been established for a reason. That reason is to prevent homeowners from getting into unsafe borrowing situations. Always error on the side of safety with your loan.

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1st Mortgage Overview

Any person borrowing money from a bank to purchase a home will have at least a 1st mortgage attached to their home. Some homeowners will also have a 2nd mortgage attached to their home in addition to the 1st mortgage. Each mortgage is recorded at the county recording house at the time that the mortgage was taken out. The only difference between a 1st mortgage and a 2nd mortgage is that the 1st mortgage was recorded before the 2nd mortgage. Homeowners take out 2nd mortgages for one main reason: to avoid paying mortgage insurance on their 1st mortgage. Anytime a mortgage loan amount exceeds 80% of the value of the property, the lender will require additional insurance to be paid along with the payment on that mortgage. This insurance is known as MI (Mortgage Insurance) or PMI (Private Mortgage Insurance). This payment can sometimes amount to several hundred dollars per month. Mortgage insurance does not benefit the borrower at all. It only provides insurance to the lender. To avoid having this mortgage insurance tacked on to a mortgage payment, the borrower must make sure not to borrower more than 80% of the total value of the property on any one loan. This is the reason that people often borrow up to 80% of the property value on the 1st mortgage and borrow any additional money that they need on a 2nd mortgage. Most home purchasers who do not have at least a 20% down payment of their own money will have to borrower an 80% 1st mortgage and then borrow what ever else they need for the purchase on a 2nd mortgage.

Safe 1st mortgages are those that have a rate and payment that is fixed for at least five years. Most 1st mortgages take 30 years to pay off. In the beginning of that 30 year period, the loan payment are rate will be fixed for some period of time. The longer this fixed period is, the safer the loan is. On average, a first-time buyers stay in their first home for a little more than 4 years. For this reason, most first-time homebuyers should not choose a loan that has a fixed period of less than five years. At the end of the fixed period, the loan's interest rate will move to the current market rate. In a worst case scenario, This could result in a very large jump in monthly payment.

A further risk factor is added by selecting a loan that has interest-only payments in the beginning. Normally this interest-only period last for five years. Many loans now have interest-only period of ten years as well. Five years is considered a safe period for interest-only payments. Even in this case, the homebuyer should consider whether or not they could afford the payment if they remain in the home more than five years and the payments become principal and interest. Interest-only periods of at least five years are not that bad for homebuyers. They give the home buyer a lot more flexibility in payments. The borrower can make additional payments toward principal if they want to, but they don't have to. The interest-only option allows homebuyers to qualify for more home that a fully-amortized payment (principal and interest) because the payment is lower.

 

2nd Mortgage Overview

2nd mortgages can have a fixed or a variable interest rate. Their total payment period are normally 20, 25, or 30 years. A fixed rate 2nd mortgage will have the interest rate fixed for the entire lifetime of the loan. The loan amount will be fixed as well. These are true fixed rate loans. These fixed 2nd mortgages are sometimes called HELOANs (Home Equity Loans).

A variable rate 2nd mortgage is usually a line of credit, just like a credit card. They are sometimes called HELOCs (Home Equity Line of Credit). They normally last for 20, 25, or 30 years. The interest rate will normally be the Prime Rate (8.25% at the time of this writing) plus some fixed margin. The interest rate on one of these types of loans will often be described in terms such as this, "Prime + 2%." The current interest rate on such a loan would be 10.25% (Prime rate, Which is currently 8.25%, + 2.00%). The trouble with these type of loans is the the Prime rate goes up every time the Fed raises raises. The Fed raises a rate that is called the Federal Funding Rate. The Prime Rate increases lockstep with increases to the Federal Funding Rate. Ina two year period, the Fed has raised the Prime Rate from 4.00% (Those were the days!) to over 8.00%. A homeowner with a $100,000 2nd mortgage tied to the Prime Rate saw their monthly mortgage payment increase by $354 during that time. That is only the increase on the 2nd mortgage payment. If the first mortgage had begun to adjust, that payment would have risen as well. It is recommended to get a 2nd mortgage with a fixed rate if possible.

 

 

 

 

 

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Brought To You By
Mark Harmon, Realtor

CalHFA Preferred Loan Officer
USA Realty and Loans

Brokerage Main Office
3994 Carson St.
San Diego, CA 92117