10.5 Buying a House With a Mortgage 631 The two most popular types of mortgage loans available today are the conventional loan and the adjustable-rate loan (or variable-rate loan ). The major difference between the two is that the interest rate for a conventional loan is fixed for the duration of the loan, whereas the interest rate for the variable-rate loan may change every period, as specified in the loan. We will first discuss the requirements that are the same for both types of loans. The size of the down payment required by the lender depends on many factors, including the source of the loan, the current economic environment, the buyer’s credit score (see the Mathematics Today box on page 632), and the location and age of the property. The amount of the down payment required can vary from 0% for some Veterans Affairs loans (see Mathematics Today box on page 637) to as high as 50% of the purchase price. In addition to a down payment, the lender may require the buyer to pay one or more points . Points are interest prepaid by the buyer and may be used to reduce the stated interest rate the lender charges. One point is equal to 1% of the loan amount. This reduction in the interest rate allows the lender to reduce the size of the monthly mortgage payment, which enables more people to purchase homes. However, because points are considered interest, the rate of interest that lenders state when you are applying for a mortgage is not the annual percentage rate (APR) for the loan. Determining the APR involves a number of steps, including adding the amount paid for points to the total interest paid. The APR can then be determined using an APR table, a calculator, or an Internet website. Often, when shopping for a mortgage, a buyer may have two choices: pay points and get a lower interest rate, or not pay points and get a higher interest rate. Websites such as HSH.com allow potential buyers to research whether paying points is to their advantage. Conventional Loans Example 1 illustrates purchasing a house with a conventional mortgage loan. Definition: Homeowner’s Mortgage A homeowner’s mortgage is a long-term loan in which the property is pledged as security for payment of the difference between the sale price and the down payment. Did You Know? The Benefits of Home Ownership Most of us are aware that a big part of the American dream is to own your own home. What we may not realize is that in addition to having a place to call your own, several important financial benefits occur when you own your own home. First, instead of paying rent to someone else, you make a mortgage payment that builds the equity in your home. Equity is the difference between the appraised value of your home and your loan balance, and it usually increases with each payment you make. As years go by, this equity may also help you qualify for other loans such as college and car loans. Second, the interest and real estate taxes you pay (in most cases) are deductible on your federal income tax returns. These deductions can add up to significant savings each year and may result in a larger tax refund. Finally, over time you can typically expect your home to increase in value. Thus, your home not only becomes your place of dwelling; in most cases, it also serves as a wise financial investment. Example 1 Down Payment and Points The Martins wish to purchase a house selling for $249,000. They plan to obtain a loan from their bank. The bank requires a 15% down payment, payable to the seller, and a payment of 2 points, payable to the bank, at the time of closing. a) Determine the Martins’ down payment. b) Determine the amount of the Martins’ mortgage. c) Determine the cost of the 2 points paid by the Martins on their mortgage. Solution a) The down payment is 15% of $249,000, or 0.15 $249,000 $37,350 × = b) The mortgage on the Martins’ new home is the selling price minus the down payment. $249,000 $37,350 $211,650 − = c) Each point equals 1% of the mortgage amount, so 2 points equals 2% of the mortgage amount. 0.02 $211,650 $4233 × = At the closing, the Martins will pay the down payment of $37,350 to the seller and the 2 points, or $4233, to the bank. 7 Now try Exercise 17 Susan Law Cain/ Shutterstock
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