Buying a Home and Committing to a Mortgage can be very scary

A home mortgage loan is the largest debt that most Americans will take on in their life time. As such, making the decision to take out a mortgage is not one that most first time home buyers take lightly. Not only will your monthly mortgage payments probably be the largest bill that you face each month, but the total amount of debt realized with a home mortgage loan can have a staggering, and sobering effect on the first time home buyer.

I can remember the months leading up to my decision to fill out a mortgage application. I had nightmares about loosing my job, not being able to keep up with my payments and finding myself homeless. And those were on the good nights when I was able to sleep at all!

Committing to a Home Mortgage does not have to cost you your sleep

In hindsight I realize that the fear that I faced when considering a home mortgage loan was irrational and the stress that I put myself under unwarranted. However, at the time, it did not seem that way.

Let’s take a closer look at common mortgage fears.

The major one is that you will not be able to carry the debt responsibility and you will loose your house.

OK, worse case scenario, you are not able to keep up with the payments, the lender forecloses and you do loose your home. What are you really loosing? Something that you do not have right now anyway! Therefore, even with the worse case scenario, you will not be any worse off than you are right now. Furthermore, it is important to realize that the chances of the lender foreclosing are pretty slim. The lender does not really want your home, he wants you to make good on your home mortgage loan, and will usually work with you to make that happen.

You should also remember that the fear of loosing your home is one that you already faced and survived. When you signed your first lease on an apartment you were taking that same chance. If you were not able to pay your rent your landlord would have made you leave your home. Taking out a mortgage can be less scary once you realize that this is a fear you have already faced and conquered.

Knowing you can afford the mortgage will allay a lot of fears

You can lesson the amount of fear that you will experience when you sign on the dotted line of a mortgage application if you are confident that you will be able to handle the monthly payments. Therefore, it is important to take stock of your financial situation before applying for a mortgage.

Sit down with a real estate agent and honestly discuss your financial situation, this includes your income and your expenses. Determining how much of a home mortgage loan you can comfortably afford is essential to having financial confidence and avoiding common mortgage fears.

The ARM (adjustable-rate mortgage) and all of its exotic and hybrid relatives has become the norm for simple economic reasons. In order to allow consumers to lock in an interest rate over a 10- to 30-year period—standard fixed-rate durations—banks and other lenders had to demand a higher interest rate overall. Remaining solvent is key for everyone in the money business, and it would not work for a lender to offer the lowest rate available and promise to maintain that rate without increase while interest rates overall are fluctuating wildly. Thus lenders have to make sure that rising rates won’t catch them short. Money lent at 6% for 30 years is tied up with no hope of more income being gained from it.

ARM’s, on the other hand, allow lenders to maximize profit at a time when rates are rising and allow borrowers to minimize risk as they can be assured that, depending on the formula they’ve opted for, their rate will be the lowest possible at any given time. A 3/1 ARM remains static for three years, then adjusts every year after that. If rates are rising, that’s three years at a lower rate before the borrower has to play catch-up at a higher rate. A 5/1 ARM is static for five years, and so on. The first number in the formula represents a variation on the fixed-rate mortgage, as it specifies the number of years during which the rate and payments will be locked in at the original contract level.

For the past decade, mortgage interest rates have dropped rapidly in response to several factors. As a result, the housing market has boomed, creating the “bubble” of rapid price increases and rabid new-home construction. With rates in the neighborhood of 5%, many buyers who couldn’t afford a $200,000 mortgage at a higher rate jumped into the market and locked in as many as 5 years at the lowest rate they could negotiate.

But the interest rate appears to have bottomed out. The current trend is upwards, with Freddie Mac, the country’s largest secondary market mortgage company, reporting May, 2006, interest rates at 6.22% with a distinct upward trend apparent over the past six months with a low of 5.76% in January. Given the direction mortgage interest rates are taking, home buyers who agreed to a 3/1 ARM a year ago may well be in for a shock in another year when they find that their payments will be adjusted drastically to accommodate the difference. Meanwhile, those buyers are in a negative amortization situation, where they will owe more after each payment than they did prior to sending in the money.

Meanwhile, fixed-rate mortgages have seen very minor interest-rate changes since 1971. They have hovered 7.31 % in April, 1971 and 6.60% in May, 2006. That’s 6.6% locked in for 30 years as opposed to 6.22% locked in for only 3 to 5 years with an unknown change to follow at the end of that period. Given that 1981 saw fixed-rate mortgage reach an all-time high of 16.83%, and given that inflation is nearing crisis levels now as it was then, there is no guarantee that that 5.x% ARM won’t jump to double-digits somewhere down the line.

Why is this critical? Because most home buyers in the current market are over-extended, having borrowed the maximum they could manage while interest rates were low enough to keep their mortgage payments within reach of their incomes. Judging by the foreclosure rate, few of them were wise enough to set up a saving plan that would ensure that when the rates rose and their mortgage payments jumped they’d have the money to either pay off the mortgage in its entirety or accommodate the higher numbers.

Refinancing has become a way of life for many borrowers. This might be the right time for a refi if your mortgage payments will be beyond your ability to pay should the rate go to 9%, 10% or higher. Now is the time to make the calculations, take a hard look at the situation, and think about locking in that slightly higher but infinitely more stable 7.31% for as many years as you think you’ll need. Make an appointment with your lender or a trusted accountant and be merciless in your judgment. The cost of a refi with a long-term fixed-rate mortgage as the goal might be just what you need to keep you and your family in your home and out of bankruptcy.