Today's homebuyer has more financing options than have ever been available before. From traditional mortgages to adjustable-rate and hybrid loans, there are financing packages designed to meet the needs of virtually anyone.

While the different choices may seem overwhelming at first, the overall goal is really quite simple: you want to find a loan that fits both your current financial situation and your future plans. Though this article discusses some of the more common loan types, you should spend time talking with different lenders before deciding on the right loan for your situation.

General categories of loans
Most loans fall into three major categories: fixed-rate, adjustable-rate, and hybrid loans that combine features of both.

• Fixed-rate mortgages
  As the name implies, a fixed-rate mortgage carries the same interest rate for the life of the loan. Traditionally, fixed-rate mortgages have been the most popular choice among homeowners, because the fixed monthly payment is easy to plan and budget for, and can help protect against inflation. Fixed-rate mortgages are most common in 30-year and 15-year terms, but recently more lenders have begun offering 20-year and 40-year loans.
  
   
• Adjustable-rate mortgages (ARM)
  Adjustable-rate mortgages differ from fixed-rate mortgages in that the interest rate and monthly payment can change over the life of the loan. This is because the interest rate for an ARM is tied to an index (such as Treasury Securities) that may rise or fall over time. In order to protect against dramatic increases in the rate, ARM loans usually have caps that limit the rate from rising above a certain amount between adjustments (i.e. no more than 2 percent a year), as well as a ceiling on how much the rate can go up during the life of the loan (i.e. no more than 6 percent). With these protections and low introductory rates, ARM loans have become the most widely accepted alternative to fixed-rate mortgages.
  
   
• Hybrid loans
  Hybrid loans combine features of both fixed-rate and adjustable-rate mortgages. Typically, a hybrid loan may start with a fixed-rate for a certain length of time, and then later convert to an adjustable-rate mortgage. However, be sure to check with your lender and find out how much the rate may increase after the conversion, as some hybrid loans do not have interest rate caps for the first adjustment period.

Other hybrid loans may start with a fixed interest rate for several years, and then later change to another (usually higher) fixed interest rate for the remainder of the loan term. Lenders frequently charge a lower introductory interest rate for hybrid loans vs. a traditional fixed-rate mortgage, which makes hybrid loans attractive to homeowners who desire the stability of a fixed-rate, but only plan to stay in their properties for a short time.

Balloon payments
A balloon payment refers to a loan that has a large, final payment due at the end of the loan. For example, there are currently fixed-rate loans which allow homeowners to make payments based on a 30-year loan, even thought the entire balance of the loan may be due (the balloon payment) after 7 years. As with some hybrid loans, balloon loans may be attractive to homeowners who do not plan to stay in their house more than a short period of time.

Time as a factor in your loan choice
As has been discussed, the length of time you plan to own a property may have a strong influence on the type of loan you choose. For example, if you plan to stay in a home for 10 years or longer, a traditional fixed-rate mortgage may be your best bet. But if you plan on owning a home for a very short period (5 years or less), then the low introductory rate of an adjustable-rate mortgage may make the most financial sense. In general, ARMs have the lowest introductory interest rates, followed by hybrid loans, and then traditional fixed-rate mortgages.

FHA and VA loans
U.S. government loan programs such as those of the Federal Housing Authority (FHA) and Department of Veterans Affairs (VA) are designed to promote home ownership for people who might not otherwise be able to qualify for a conventional loan. Both FHA and VA loans have lower qualifying ratios than conventional loans, and often require smaller or no down payments.

Bear in mind, however, that FHA and VA loans are not issued by the government; rather, the loans are made by private lenders but insured by the U.S. government in case the borrower defaults. Remember too, that while any U.S. citizen may apply for a FHA loan, VA loans are only available to veterans or their spouses and certain government employees.

Conventional loans
A conventional loan is simply a loan offered by a traditional private lender. They may be fixed-rate, adjustable, hybrid or other types. While conventional loans may be harder to qualify for than government-backed loans, they often require less paperwork and typically do not have a maximum allowable amount.
 

Refinancing your home can be an excellent way to bring down your monthly mortgage payment, raise cash, or consolidate debts with high interest rates. However, you need to do your homework before deciding to refinance. One important factor is the difference between current interest rates and the rate of your original loan. You also need to take into account the amount of time it will take to recoup the costs of refinancing.

When should you refinance?
Some common reasons homeowners refinance include:
 

• Lower monthly mortgage payments
• Convert an adjustable rate mortgage (ARM) to a fixed-rate mortgage
• Raise funds for family expenses (i.e. college tuition)
• Pay off high-interest loans
• Home improvements

The old rule of thumb is that you should refinance your home if interest rates fall more than 2 percent. That's because refinancing usually involves most of the same closing costs (loan origination fee, prepaid interest, etc.) as the original loan. For anything less than 2 percent, the savings on your monthly mortgage payment might not be significant enough to be worth your while.

Savings vs. time
For some homeowners, though, the 2 percent rule is not as important as the time needed to break even on the refinancing. For instance, if it costs $3,000 to refinance a house, and the monthly mortgage payment is lowered by $90, it would take almost 3 years for the savings to cover the costs of refinancing.

If all the information (survey, title search, etc.) for your old loan is still current, however, the lender may be willing to waive many of the fees. In addition, you may be able to roll the closing costs of a refinance loan into the new note. In other words, you don't avoid the closing costs, but instead pay them back over time along with the rest of the loan. If you consider this option, be sure to calculate the potential savings vs. the expense of paying off a higher principal balance.

Keep in mind that refinancing usually lengthens the time it takes to pay off your house. If you are 3 years into a 30-year mortgage and then refinance with a new 30-year loan, you'll end up making payments on the house for 33 years. Nevertheless, if the monthly savings are substantial enough, you still could end up paying much less over the long haul with the new loan.

Adjustable Rate Mortgages (ARMs)
Timing can also be a factor in switching from an ARM to a fixed-rate loan. For example, rising interest rates might influence you to covert your ARM into a fixed-rate loan if you plan to stay in your house for several more years.

Conversely, you may plan to move in a year or two, and find a lender who is willing to offer you dramatic interest rate savings with an ARM. In this case (and as long as the closing costs are minimal), it might make sense to switch from a fixed-rate loan to an ARM.

Equity
Refinancing with a new loan doesn't mean you have to give up all the money you've paid towards your old mortgage. With each payment, you build up a certain amount of equity in a property--which is the amount you've paid on the principal balance of the loan.

For example, if you have a $100,000 loan at 8 percent, you would build about $2,800 worth of equity in the first 3 years. Thus, if you refinanced, the new loan would only amount to $97,200.

Raising cash with home equity loans... use caution
If you've built enough equity, you can refinance in order to take cash out of the property. Perhaps you need money to pay off your credit cards, add a new bathroom, or cover the costs of braces for a child. Regardless, lenders will typically allow you to borrow against the equity you've built in your house, plus appreciation (often up to 75 percent of the current appraised value). These types of loans are also called home equity loans.

Be cautious, however, of lenders offering 100 percent or 125 percent home equity loans--their rates are often markedly higher than traditional lenders. In addition, any amount you borrow that is above the market value of the house is NOT tax deductible.

Talk to your lender
With all the different types of refinancing loans available today, you should take some time to shop around and speak with several lenders before making a decision. Be sure to discuss all the expenses and benefits, as well as what will be expected of you, in advance. The more you educate yourself, the better your chances of finding the right refinancing package.
 

One of the greatest financial aspects of buying a home is the ability to leverage your money. Simply put, leverage allows you to use a small down payment and financing to purchase a larger investment. For example, if you bought a $125,000 home with 10 percent down, you leveraged the $12,500 down payment to purchase an asset worth 10 times that amount!

Appreciation
The benefits of leverage really become apparent with appreciation, or the rise in value of a property. Using the above example, say you were to live in the house for 5 years, and during that time property values in your area were to rise an average of 2.5 percent a year. Your home would then be worth over $141,000. By putting only 10 percent down, you get to enjoy the appreciation for the full amount!

Paying yourself
In addition to the 10 percent down, you'll also have to make mortgage payments. But with each payment, a certain amount of money is being used to pay down the principal balance that you owe. This is called building equity. So in the event you sell your house, not only can you realize a profit from your leveraged money, you also have a chance to pay yourself back for the money you've put in over the years. No wonder so many people consider a home an excellent investment!

Understanding how much you can afford is one of the most important rules of home buying. Depending on your individual situation, your budget can affect everything from the neighborhoods where you look, to the size of the house, and even what type of financing you choose.

Bear in mind, however, that lenders will look at more than just your income to determine the size of the loan. Likewise, you may find that there are some creative financing options that can help boost your purchasing power.

Loan prequalification vs. preapproval
One of the best ways to determine your budget is to have your real estate agent or lender prequalify you for a loan. Prequalification is different from preapproval, because it is only an estimate of what you'll be able to afford. On the other hand, preapproval is a more formal process where a lender examines your finances and agrees in advance to loan you money up to a specified amount.

What factors are important to lenders?
Banks and lending institutions will use several criteria to determine how much money they'll agree to lend. These include:

• Your gross monthly income
• Your credit history
• The amount of your outstanding debts
• Your savings--or the amount of money you have available for a down payment and closing costs
• Your choice of mortgage (i.e. 30-year, FHA, etc.)
• Current interest rates

Two important ratios
Lenders also use your financial information to figure out two, very important ratios: the debt-to-income ratio and the housing expense ratio.

• Debt-to-income ratio
  Many lenders use a rule of thumb that the amount of debt you are paying on each month (car payment, student loan, credit card, etc,) shouldn't exceed more than 36 percent of your gross monthly income. FHA loans are slightly more lenient.
  
   
• Housing expense ratio
  It is generally difficult to obtain a loan if the mortgage payment will be more than 28 to 33 percent of your gross monthly income.
   

Down payments make a difference
If you can make a large down payment, lenders may be more lenient with their qualifying ratios. For example, a person with a 20 percent down payment may be qualified with the 33 percent housing expense ratio, while someone with a 5 percent down payment is held to the stricter 28 percent ratio.

Other ways to improve your purchasing power
 

• Gifts
  If you're having trouble saving money, many lenders will allow you to use gift funds for the down payment and closing costs. However, most lenders require a "gift letter" stating the gift doesn't have to be repaid, and will also require you to pay at least a portion of the down payment with your own cash.
  
   
• Negotiating Closing Costs
  Through negotiation, some sellers may agree to pay all or most of your closing costs (for example, if you agree to meet their full asking price). If you choose to try this, make sure to ask your real estate agent for advice.
  
   
• Loan Programs
  Many local governments have special loan programs designed to help first-time homebuyers. Loans may be available at reduced interest rates, or with little or no down payments. Check with your local housing authority for more information.
  
   
• Loan Types
  Some homebuyers choose Adjustable Rate Mortgages (ARMs) because of low initial interest rates. Others opt for 30-year loans because they have lower monthly payments than 15-year loans. There are significant differences between different loans, so make sure to discuss the pros and cons of different loans with your agent or lender before making a decision.
   

Excluding property taxes and insurance, a traditional fixed-rate mortgage payment consist of two parts: (1) interest on the loan and (2) payment towards the principal, or unpaid balance of the loan.

Many people are surprised to learn, however, that the amount you pay towards interest and principal varies dramatically over time. This is because mortgage loans work in such a way that the early payments are primarily in interest, and the later payments are primarily towards the principal.

In the beginning... you pay interest
To help calculate monthly payments for loans based on different interest rates, lenders long ago developed what are known as "amortization tables." These tables also make it fairly easy to calculate how much money of each payment is interest, and how much goes towards the principal balance.

For example, let's calculate the principle and interest for the very first monthly payment of a 30-year, $100,000 mortgage loan at 7.5 percent interest. According to the amortization tables, the monthly payment on this loan is fixed at $699.21.

The first step is to calculate the annual interest by multiplying $100,000 x .075 (7.5 %). This equals $7,500, which we then divide by 12 (for the number of months in a year), which equals $625.

If you subtract $625 from the monthly payment of $699.21, we see that:
 

• $625 of the first payment is interest
• $74.21 of the first payment goes towards the principal

Next, if we subtract $74.21 (the first principal payment) from the $100,000 of the loan, we come up with a new unpaid principal balance of $99,925.79. To determine the next month's principal and interest payments, we just repeat the steps already described.

Thus, we now multiply the new principal balance (99,925.79) times the interest rate (7.5%) to get an annual interest payment of $7,494.43. Divided by 12, this equals $624.54. So during the second month's payment:

• $624.54 is interest
• $74.67 goes towards the principal.

Note: In Canada, payments are compounded semi-annually instead of monthly.

Equity
As you can see from the above example, even though you pay a lot of interest up front, you're also slowly paying down the overall debt. This is known as building equity. Thus, even if you sell a house before the loan is paid in full, you only have to pay off the unpaid principal balance--the difference between the sales price and the unpaid principle is your equity.

In order to build equity faster--as well as save money on interest payments--some homeowners choose loans with faster repayment schedules (such as a 15-year loan).

Time versus savings
To help illustrate how this works, consider our previous example of a $100,000 loan at 7.5 percent interest. The monthly payment is around $700, which over 30 years adds up to $252,000. In other words, over the life of the loan you would pay $152,000 just in interest.

With the aggressive repayment schedule of a 15-year loan, however, the monthly payment jumps to $927-for a total of $166,860 over the life of the loan. Obviously, the monthly payments are more than they would be for a 30-year mortgage, but over the life of the loan you would save more than $85,000 in interest.

Bear in mind that shorter term loans are not the right answer for everyone, so make sure to ask your lender or real estate agent about what loan makes the best sense for your individual situation.