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interest rate adjusts once a year. The amount by which the interest rate adjusts on an ARM each year is very small — like .25% because there are limitations on how much it can change. Also, it can go up or down, depending on how market interest rates have moved. The advantage of an ARM is that, with a lower upfront rate, a buyer can afford a more expensive home initially and adapt to a higher payment over time. ARMs are also referred to as Variable Rate Mortgages .
Period of time the interest rate is xed.
3 / 1 ARM
After 3 years, the interest rate adjusts once a year.
Qualifying for a Mortgage. Recall that in Chapter 7, The Credit Conundrum, you learned about debt-to-income (DTI) ratio, which is a test that lenders apply to determine whether a borrower is a credit risk. Currently, to qualify for a mortgage, a borrower’s maximum DTI ratio must be 43% or less. If your life-long dream is to own your own home, steer clear of debt, particularly credit card debt. Another thing a lender will look at to determine whether you are a qualified borrower is affordability . That is the percent of your monthly income that would be required to pay your housing expenses including a mortgage payment, property taxes, and insurance. Typically, most lenders prefer that no more than 28% of the homeowner’s monthly gross income is spent on housing. That means if your gross pay is $5000 per month, you will only qualify for a home loan that keeps your housing costs at about $1400 per month or less. Security Interest. When a bank or other creditor makes a home loan, the borrower signs a promissory note , agreeing to repay the loan. The lender gets more than the borrower’s promise to repay, however. The borrower signs a mortgage (also referred to as a deed of trust ) which pledges the home to the lender as security (collateral) for repayment of the loan . If the borrower defaults on the loan by failing to make their monthly payments, the lender can foreclose on the mortgage or deed of trust, which means they can force a sale of the property to recover their money. Reflect on Learning: What is a mortgage? Answer: Basically it's a loan to finance the purchase of a home. What is the difference between a fixed rate mortgage and an ARM? Fixed has the same interest rate throughout the term of the loan; an ARM adjusts. Do you recall what a DTI is? If not, go back to Chapter 7 and reread that section! III. The Financial Benefits of Homeownership Building Wealth through Homeownership. Historically in the U.S., homeownership has been one of the best ways to build personal wealth. This is due to the ability of a homeowner to build equity in their property . Equity is an important financial literacy concept. In the context of homeownership, it refers to the value of the home minus the debt on it . Equity belongs 100% to the owner and builds net worth (wealth). Some equity is created immediately, and some builds over time. Here are four ways homeownership can build wealth: Down Payment. As you learned above, a down payment of about 20% of the price of the home is paid upfront by the buyer. Many people save for years in order to be able to afford a down payment. Once the home is bought, the down payment doesn’t disappear. It converts to equity. Assume that a new homeowner bought a home for $175,000 making a downpayment of 20% ($34,000). Their immediate equity in the property is $34,000. It’s like putting that money away in savings. When they sell the house, they get that money back. PRODUCT PREVIEW
Chapter 9 | Home is Where the Mortgage or Lease Is 156
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