Choosing a Loan

There are hundreds of lenders offering a multitude of loan options that makes determining the best loan for your situation a complex endeavor. Since you may be making home payments on a loan anywhere from 15 years to 40 years depending on the term, it is imperative that you work closely with your lender. We also recommend that compare mortgage rates from reputable lenders. You can find many tips on choosing the right lender and loan that works best for you. Be sure to ask if there are any special programs (like First Time Home Buyers) that might be available in your area.

What follows is a breakdown of the available residential loan programs.

Types of Minnesota Residential Home Loan Programs

• Fixed-rate loans

This is a home loan with an ensured interest rate that will remain at a specific rate for the term of the loan. About 75 percent of all home mortgages have fixed rates. One reason for this is that most homes sold are to buyers who plan on living in their property for many years. During the first few years, only a small portion of the payment pays off the principal. Most goes to paying interest. When you choose the length of your repayment (usually 15, 20 or 30 years), keep in mind that while shorter term loans may have higher monthly payments, they also let you pay less interest and build equity faster.

• 30-year fixed-rate loan

The most popular loan is a 30-year fixed-rate loan. The reasons include:

1. It provides the borrower with reasonable monthly payments.
2. It’s ideal for the homebuyer who plans on remaining in the home for more than five years.

• 20-year fixed-rate loan

The 20-year mortgage often offers a lower interest rate when compared to a 30-year loan. This loan amortizes principal and interest over a 20-year period, ten years less than the traditional 30-year mortgage. This may save you a considerable amount of total interest when paid over the life of the loan.

• 15-year fixed-rate loan

The advantage of a 15-year mortgage is that its interest rate is generally lower than a 30-year or 20-year loan. Such a short-term loan will save you a significant amount of interest over the life of the loan. By paying off the loan in only fifteen years, you also build up equity in your home sooner. A 15-year loan allows you to own your home clear of debt much quicker when compared to longer term loans. This may be important if you are approaching retirement or have other large expenses to cover such as financing your children’s education. However, the monthly payments you make on a 15-year loan will be significantly higher than those you make on a 30-year or a 20-year loan for the same loan amount.

• Adjustable-rate loans

With an adjustable-rate mortgage (ARM), the interest rate you pay is adjusted from time to time to keep it in line with changing market rates. This means that when interest rates go up, your monthly loan payment may go up as well. On the other hand, when interest rates go down, your monthly loan payment may also go down. ARMs are attractive because they may initially offer a lower interest rate than fixed-rate loans. Since the monthly payments on an ARM start out lower than those of a fixed-rate loan of the same amount, you should be able to qualify for a larger loan.

The chief drawback, of course, is that your monthly payment may increase when interest rates go up. The types of people who typically benefit from an ARM are those that are planning to move or refinance in the near future, people with a high likelihood of increasing their income in later years, and people who need lower initial interest rates on their loans to be able to buy a home. How much your payment can increase will depend on the terms of your loan.

Before applying for an ARM, be sure you know how high your monthly payment can go – the so-called ‘worst-case scenario’. An ARM has two ‘caps’ or limits on how large an interest rate increase is permitted: One cap sets the most that your interest rate can go up during each adjustment period, and the other cap sets the maximum total amount of all interest adjustments over the life of the loan. The rates on an ARM usually change once or twice a year, and there is typically a lifetime rate cap (or limit) on both the amount of each individual rate adjustment, and the total amount the rate can change over the whole term of the loan.

Example: If your loan starts at 5 percent, has a 2 percent per-adjustment cap, and a lifetime adjustment cap of 4 percent, you know that your loan might go up to 7 percent the first time the rate changes. You also know that the rate can never go over 9 percent over the life of the loan (5 percent start + 4 percent lifetime cap). Only you can determine if you would feel comfortable paying this interest rate sometime in the future.

Some ARMs offer a conversion feature which allows you to convert from an adjustable-rate to a fixed-rate loan at certain times during the life of your loan. Ask your lender about this feature when researching ARMs. One important thing to know when comparing ARMs is that the interest rate changes on an ARM are always tied to a financial index. A financial index is a published number or percentage, such as the average interest rate or yield on Treasury bills.

• Interest-only Jumbo Loan

This loan is for a mortgage more than $625,000. These loans are structured like adjustable-rate mortgages. The period during which you pay interest only lasts for the first 5, 7 or 10 years. After that, typically, the rate adjusts annually and the borrower pays principal, as well as interest. At this time, your payment can go up pretty significantly, even if the interest rate doesn’t change much.

• What is an APR?

APR stands for annual percentage rate. It is the annualized cost of credit, expressed as a percentage. The APR calculation considers certain fees to reflect the cost of credit in addition to interest.

• What is LTV?

LTV stands for loan-to-value, which is the ratio of the mortgage loan amount to the property’s value. For example, if your property is worth $100,000 and $80,000 is owed on the first mortgage, the LTV ratio is 80.

Other Resources

  • Real Estate Tips & Tools

  • Brianne Lawrence

  • Debbie Grendahl

  • Lyudmila (Luda) Pederson

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