Mortgages and Deeds of Trust

If you took out a loan to buy your house, you signed a promissory note (or "note") that legally obligates you to pay back the money.

At the same time, you probably gave your lender a mortgage, is a lien on your house that provides the lender with a security interest in the property. This means that you put your house up as collateral for repayment of the loan. If you fail to pay the loan, the mortgage allows the lender to foreclose on your property.

In some states, the security interest in your house is called a "deed of trust," which is essentially the same thing as a mortgage.

You can get a mortgage loan from mortgage companies, banks, savings and loan associations or building and loan associations.

Mortgages can be either:

• Guaranteed (to be paid) by an insurance company or a federal agency like the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA)
• Conventional loans not insured by governmental agencies

Common Types of Mortgage Loans include:

• Fixed Rate Note: the interest rate and the amount you pay each month stay the same for the entire life of the loan. You'll always know how much you owe each month, and you may be able to take advantage of a low interest rate.
• Adjustable Rate Note (ARM) : The interest rate changes at regular intervals, sometimes as often as once a year, and is tied to the interest rate on U.S. Treasury securities. There is usually a "lifetime cap" of the maximum percentage points your loan can increase over the length of your loan, and restrictions on how much your loan can be adjusted upward in a particular adjustment period. An adjustable rate mortgage should include both kinds of restrictions.
• Hybrid Rate Note: The interest rate stays fixed for a certain number of years, then changes to a variable rate.
• Balloon Note: The interest rate stays fixed for a certain number of years, then the remainder of the loan amount comes due at a certain time.

Questions to consider in deciding which type of mortgage is best for you include:

• How long are you planning to stay in your home?
• What's the most you can currently afford to pay each month for housing?
• Is the economy on the upswing or the downswing?
• Will you need to take out an additional loan in the future to finance home additions or remodeling?
• How is your credit rating? The cleaner it is, the more options will be available to you.
• How much money will I have to pay up front for the loan (e.g., "points" and "loan fees")?

The Mortgage Process

Once you've narrowed down the type of mortgage you want and the mortgage lenders available to you, you'll begin applying for and "closing" (finalizing) a mortgage loan.

It's important to fill out the mortgage application thoroughly and provide copies of your earnest money agreement, tax returns, paystubs or other documents the mortgage lender requests.

If you're getting some of the money for your down payment from a relative, the mortgage lender will probably require a letter from them stating what they're contributing.

If you're "pre-qualifying" by shopping for a mortgage before you've found the home you want to buy, the mortgage lender will give you a "lock-in agreement" or loan commitment letter to guarantee the terms of your loan for a certain period of time.

If you're thinking about moving in a couple of years, it may not be prudent to take out a shorter term loan with a higher interest rate.

And don't pay upfront costs to get a lower rate if these costs are going to be more than what you would save in lower mortgage payments over the few years that you plan on staying in your home.

Watch out for:

• Bait and Switch Tactics. Don't be conned into a more expensive loan after you've applied for one with lower interest rates.
• Dishonest Mortgage Brokers. Get any guarantees in writing, and check them out with your local Better Business Bureau. All fees should be fully explained upfront.
• Negative Amortization. When your monthly payment doesn't cover the monthly interest that's due, you end up owing more on the principal amount of your loan each month. More frequent with ARMs, it's a trap you don't want to fall into.

Related Web Links:

Motley Fool Tips on Financing Your Home
Federal Reserve Board Guide to Home Mortgages

Buying & Selling Real Estate Message Board for more help