Thursday, October 18, 2007

Creative Financing

The phrase "creative financing" may scare people these days, but I encourage you to look at different scenarios when shopping around for a loan. Two general loan categories are fixed and adjustable, but within those two categories there are many different options.

A fixed loan is a safer option for the more conservative buyers as the interest rate stays the same throughout the life of the loan which is most commonly thirty years. Some lenders are offering forty year fixed loans as well. Another variation in this category is a fixed loan that offers interest only payments for the first ten years. That would make your monthly payments slightly lower for the first ten years as you would not be paying towards the principle. Fixed loans are the more expensive option meaning they come with a higher interest rate which makes your monthly payments higher.

Adjustable loans are loans that are fixed for a period of time and then adjust according to a preselected index. The most common are those that are fixed for 15 years, 10 years, or five years and then adjust yearly after that. The shorter the fixed period is, the lower the interest rate will be. People will use these loans if they are only planning to be in the home a short time, or if they want to increase their buying power; a lower interest rate will allow you to increase your purchase price.

There are other things to think about even within those two categories. One is a rate buy down, or paying points. Points are prepaid interest and are a percentage point of the loan amount. Let's say you have a loan amount of $800,000. One point would be $8,000. If you have an interest rate on a thirty year fixed loan of 7%, you can pay one point and bring that down to 6.5%. (each point does not reflect one percentage on the interest rate, only the loan amount) If you were to pay two points ($16,000), your interest rate would be 6.250%, and three points ($24,000) will bring you down to an interest rate of 6%.

The difference of paying no points and having an interest rate of 7% and paying three points and having an interest rate of 6% translates to about $500 less in monthly payments. If your savings is stronger than your income, this would be a perfect option for you. Check with your lender and see how this would work with your numbers. Also be sure and ask how long the buy down stays in place; it may be five or ten years; then the loan is re amortized over the remaining term.

With the market being at a balanced point and buyers having more room to negotiate, you can also request that the seller pays for the buy down. Also, if you are a seller and your home is sitting on the market, this could be something you offer to potential buyers.

This is why it is important to talk to a lender before you begin your search. They may have options you hadn't thought of which could affect your purchasing power. Also, you don't want to fall in love with homes you can't afford. Figuring out the financing is definitely the first step, and it is much easier to do with a professional. Let me know if you need referrals.

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