By Mike Heayn Real Estate 101
WHEN PURCHASING A HOME YOU WILL probably go to a bank to get a loan. Getting a loan from a bank is known as attaining financing. Just like a car loan, a home loan has an interest rate and set period, or term. When banks get creative, the outcome can be catastrophic — as the subprime mess lays witness to. However, conservative financing is finding its way back into the market place.
When you think of a home loan, you probably think about a 30 year fixed loan. Loans have what are known as amortization schedules, where a percentage of the payment goes to paying down the principal and the remaining amount goes to paying off the interest. Banks figure most people refinance their home loans within five years so they created a amortization schedule where a large amount of interest is paid at the beginning of the loan. If you were to qualify for a $500,000 30 year fixed loan at 6 percent, your payment would be $2,997.75 and over the life of the loan you would pay $1,079,190.95. That seems high, but financing allows you to attain an asset that you wouldn’t otherwise be able to purchase.
Other loans exist as well. One type is known as an adjustable rate mortgage, or ARM. ARM products are part of the reason that so many people got in trouble with their homes. An ARM loan typically has a low start rate, but after a fixed period the loan becomes variable. When the loan adjusts, the payment can go up. Many subprime borrowers found themselves in hot water when their payments increased, sometimes to more than double the fixed payment.
If you already have financing with a great interest rate you will not want to do a refinance, but rather add what is known as a home equity line of credit or HELOC. Taking a position behind a first trust deed, a HELOC allows a homeowner to access equity in the property without changing the terms of the first loan. Many homeowners add a HELOC to their homes for large purchases such as other real estate or remodeling. The difference between a HELOC and a home equity loan is a home equity loan takes the second position, but all of the funds are received at the close of escrow instead of an account that can be accessed.
In today’s market banks are weary of aggressive lending with creative products. In the right hands a creative loan can offer an investor better cash flow, but in the wrong hands a creative loan can be disastrous. With a return to conservative financing more people will find less loan options, but the options available are safer in today’s market place.
Originally published in the Santa Monica Daily Press print edition on March 26, 2008. Read the original PDF.