Concepts Applicable To All Mortgages

As we have already noted, most Americans will rely heavily on mortgage financing to affect the purchase of their home.  Having acknowledged that fact, we now have to study the different types of home mortgages that are available.  There are many different types of home mortgages and the short-term and long-term cost differentials on these different mortgage types can be extreme.  Whether you are a new or repeat homeowner, taking the time to make yourself aware of these different types of home mortgages could save you hundreds—maybe thousands‑ of dollars annually with regard to your mortgage payments.

Closing Costs

Any mortgage loan will have "closing costs" attached to it.  Closing costs entail the required down payment on the home, "points" charged at the inception of the loan (recall our discussion of points and the special tax treatment afforded them on page 18), loan origination charges and a variety of miscellaneous additional expenses.  The loan origination fee is that amount charged by the Bank acting as the mortgage lender to process the mortgage. The loan origination fee is typically a large expense and it is distinct from any points charged on the mortgage.  The only closing costs that are tax deductible in the year of payment are your points.

By law, the mortgage lender must provide you with a line item breakdown of your various closing costs.  This is significant, as these closing costs will vary greatly lender-by-lender.  Therefore, when you shop for your home mortgage (detailed below), a clear knowledge of the amount of your closing costs will be almost as important as determining the interest charge and the type of your mortgage.

We have just discussed options for funding the down payment on your home.  Your down payment will almost always be the most significant closing costs that you incur.  Recall that you should strive to mortgage finance 80% or less of the total purchase price of your home in order to avoid the need for home mortgage insurance.

Interest Expense

Interest expense charged on a mortgage (or any other type of loan) is the expense the lender charges the borrower for the use of the lender's money.  Think about that fact for a moment.  If you were in the lender's shoes and were about to make a long-term loan (15 or 30 years) would you charge more or less interest expense if you were unable to change the terms of the loan?  You would charge a higher rate of interest due to the uncertainty of what interest rates would be in the future.  If you as the lender had the ability to change the loan terms every year so as to readjust interest expense to conform to then-current market rates for interest, you could initially charge a lesser rate of interest at the inception of the loan.  This reality about interest expense is the basis for the difference between our two major types of home mortgages: fixed rate and adjustable rate mortgages.