If not chosen with care, mortgages, which are complex and often expensive, can negatively impact your financial standing in a huge way due to default or home foreclosure. We saw that happen far too many times during the U.S. mortgage meltdown of the past several years.

So what is the key to choosing a mortgage? There are a few steps you should take before settling on a plan.

Calculate What You Can (and Can’t) Afford

The first step might seem like a no-brainer, but it’s the most important one of all. You need to review your income and spending in order to determine if you can afford purchasing a home.

To buy a home you will need to be able to cover more than just the monthly mortgage payments. You’ll also be responsible for property taxes, insurance, utilities and maintenance and upkeep. Those costs can add up, so make sure to have plenty of financial cushion.

It’s wise to save up enough to make your monthly mortgage payments for several years before taking out a mortgage. Also, check your credit report to make sure it is correct. A better credit score can help you get a lower interest rate on your mortgage.

Study the Basics of Mortgages

Before hitting the mortgage market and actively seeking a loan, be sure you understand the commitment, terms and potential risks of the product.

This step is made more complicated by the fact mortgages come in many shapes and sizes. Some mortgages come with fixed interest rates while some have adjustable rates. Some penalize you for paying the balance off early, while some include a big payment due at the end of the loan.

You will want to calculate exactly how much your monthly payments will be in the immediate future, as well as five, 10 or 15 years down the road. You can find mortgage calculators online (or even on your smart phone) to give you a ballpark idea of how much you will owe each month, but consulting with the potential lender is the safest policy.

Beyond finding how much you’ll owe each month, dig a bit deeper to unearth any potential fees. Fees commonly associated with taking out a mortgage can include loan underwriting fees, broker fees and transaction costs.

Shop, Shop, Shop

You can’t spend too much time shopping around for a mortgage. If you’re new to home buying, the mortgage-shopping process should probably start with a visit to a housing counselor or real estate attorney who can help decipher the sometimes-complicated search for a loan.

Once you have consulted a professional, you should compare loans from a variety of sources before deciding on a plan. Home loans are available from thrift institutions, commercial banks, credit unions and mortgage companies. Those different types of institutions — and even different companies within those fields — often offer very different prices, so get more than one or two quotes.

A good place to start the preliminary search for a mortgage is the Internet. You can find a customizable mortgage rates search tool here.

A good way to estimate your mortgage costs is a mortgage calculator, which can be found here.

What is a Short Sale?

Borrowers who are unable to make their monthly mortgage payments sometimes have the option of selling their homes for less than the amount they owe on it, in order to at least recover some of the value. This is called a “short sale,” and has become more common since the mortgage crisis, causing mortgage lenders to take more aggressive action to recover the unpaid mortgage balances.

Many homeowners believe that once they “turn in the keys” on their mortgaged property, they also relinquish all obligations to pay the remaining mortgage. While often this is the case, as lenders realize that homeowners who reach this point have very little income or assets left, there has recently been an increase in the attempts by collection agencies to recoup these losses.

Negative Equity on the Rise

This problem is expected to continue in the next year, as over 10 million homeowners are believed to currently owe more on their homes than the homes are worth. If you have a mortgage and do not have any other option than a short sale or a foreclosure, be sure to talk to your lawyer or make sure that there is an agreement between you and your mortgage lender before simply walking away from your mortgage.

In a press release from the Consumer Credit Counseling Service (CCCS) of Greater Atlanta, Director and professor of law Frank Alexander advised that “no homeowner should ever simply ‘walk away’ or ‘turn in the keys’ without receiving a document that absolves them of all liability.” Take the necessary steps to get the documentation and protect yourself against a post-foreclosure lawsuit, so when you walk away you know that your unpaid mortgage balance will not follow you.

If your lender is given the option to modify your mortgage loan or foreclose, what will they choose to do? This is a question facing the millions of American families who have fallen behind on their loan payments and tried to negotiate a loan modification. Unfortunately for many, the answer has been that the lender will simply foreclose. However, the Making Home Affordable Program attempts to give loan servicers an incentive to successfully modify loans, and slow the recent rise in home foreclosures in the US.

The Costs of Loan Modification

Currently, mortgage servicers actually have a disincentive to modify loans, as the process can often result in higher overall costs to the them. Mortgage servicers are the independent companies hired by your lending institution to manage your loan and collect payments on them, and are often independent of the bank. Although foreclosures cost homeowners, the lending institutions and their shareholders more money (often as much as $50,000 per foreclosure), this loss can be recovered by the loan servicer; in fact, mortgage companies often stand to make money off of a foreclosure.

This is because the main sources of income for loan servicers are monthly fees that are tied to the principal amount of the loan, and so these companies are generally opposed to modifications that reduce the value of the principle. And while they risk the loss of fees during a foreclosure, the management expenses incurred by the mortgage servicer during a modification are often much more costly than simply foreclosing on a bad loan.

Making Home Affordable Plan

The Making Home Affordable Program attempts to give these institutions incentive to oversee successful loan modifications, and keep them from prematurely foreclosing. The $75 billion program has over 65 participating mortgage servicers who have agreed to the terms of the plan, and will receive incentivized funding for completing loan modifications.

To determine if you are eligible for the loan modifcation, you will have to answer the following questions:

• Is your home your primary residence?

• Is the amount you owe on your first mortgage loan equal to or less than $729,750?

• Are you having trouble paying your mortgage? (For example, have you had a significant increase in reduction in your income since you got your current loan or have you suffered a hardship that has increased your expenses?)

• Did you get your current mortgage before January 1, 2009?

• Is your payment on your first mortgage (including principal, interest, taxes, insurance and homeowner’s association dues, if applicable) more than 31% of your current gross income?

If your answer to the above questions is “yes,” than you may be eligible for a Home Affordable loan modification. Contact your loan servicer for more information.

For an in depth look at the incentives for loan servicers, go here (PDF). More information on the Making Homes Affordable plan is available on the website, at www.makinghomeaffordable.gov.

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For first time Homebuyers:

With the lowest mortgage rates in years and the fall of home market values, economists say this is the best time for buying a house. But before making that decision here are some tips to consider:

FICO or credit score should be 740 or higher

Factors like having any outstanding credits or paying off your credit card balance on time affects your credit ratings. Credit scores range from 300 to 850. These scores affect how much interest you pay. Banks regard lenders with credit scores lower than 740 to be risks, thus they demand higher rates on loans granted.

Choose the best plan that suits you

There are different types of mortgages available: Fixed rates and Adjustable Fixed Mortgages are the most popular ones.

Fixed rates

they offer a fixed rate of interest over a pre-determined number of years. If your fixed plan is set at 5% interest rate per annum over 15 years APR, your monthly payments would not change over the course of the mortgage.

Adjustable Fixed Mortgage

these require a higher degree of understanding; these are plans which start with lower interest rates at fixed rates but after the set period time the interest fluctuates.

Make at least a 20% down payment

Mortgage providers like banks require homeowners who can’t make a 20% downpayment to get Private Mortgage Insurance or PMI. Homeowners who can’t make a 20% downpayment are considered high risk, thus banks require insurance just in case you default or even worse, go into foreclosure on your property. These are not tax deductible so you carry the full weight of the insurance. These are in addition to your monthly payments.

Tip: Try getting a Piggyback loan. These types of loans are often referred to as 80-10-10 or 80% for the amount of loan, 10% actual downpayment and 10% for the second mortgage on your previous home. This allows you to make that 20% downpayment, thus avoiding PMI payments. Note: this is only available for those that already own a house.

Keep track of the latest mortgage rates and numbers

Information on the latest rates is readily available from a variety of sources, ranging from your daily newspaper to the internet. Be sure to get your numbers from the latest and reliable sources available. MyBankTracker offers real-time news and the latest numbers from your banks and a comprehensive comparative study about them. MyBankTracker  keeps you in track of your local banks current rates and compares them with other banks.

Do the Math

Talk with your bank and learn what their formula for getting your monthly payment is. Know how much down payment you’re can afford, the type of loan and after getting your monthly payment, compare it with your monthly income. If you think it is the best deal available, but it takes more than 50% of your monthly income, which deprives you of a little spending cash, you need to decide if it’s right for you.

Get that $8,000 tax credit

An $8,000 tax credit for first time homebuyers has helped boost home sales; it is included in President Obama’s economic stimulus package. If you’re going to make a $20,000 downpayment for your home, after deducting the $8,000 tax credit then it’s just like making $12,000 for your downpayment.

For homeowners with current mortgages and in danger of defaulting

Refinancing

With mortgage rates hitting record lows maybe its time to get a new deal with your mortgage. If you previously had a 6% APR on your 30 Fixed Rate Mortgage Plan and applied for a new one which stands at 5 percent on the same plan, you can get up to a 1 percent reduction on your APR. The average savings that could be made from a $200,000 loan when adjusted with a drop of 1 percent is $2,000 a year. This means a $200 reduction in your monthly payments but also a $60,000 saving when computed for 30 years.

Note: Credit Scores are negatively affected when you apply for refinancing. Homeowners who make on-time payments are also affected and find their credit scores go down if they go for refinancing. If you are an on-time payer you should consider how this could affect your credit score. Credit Scores directly affect your credit limit; a lower credit score means a lower credit limit. Mortgages under Fannie May and Freddie Mac are the only ones covered by President Obama’s Making Homes Affordable Program.

Consider making your payments in a weekly and not a monthly basis

Making a budget gives you a better control of your finances. Taking into account your mortgage in your weekly expenses leaves you with a better perspective on how to reconcile them with your income. Budget your payments like budgeting your groceries for the week. It makes it simpler and easier to handle.

Loan Modification

Lowering your monthly payments by negotiating the amount of loan or principal is also an option. This is done by taking into consideration the amount of payments you have already made on the principal. Upon determining the amount of principal left, a new loan plan is then agreed upon. The amortization period may be extended, but the loan modification monthly payments become smaller because of the lower principal needed for the loan.

Parting shot

Economists say that this is the best time for buying a new home with the numerous government programs that encourage first time homebuyers. Mortgage interest rates which are the lowest in decades and the 20% drop in home value have also made great bargains for everyone. Getting the best deal is not always landing the house of your dreams. Buying a house is one of the biggest decisions you’re to make in your life. These are just tips on how to get the best hand in the game. It isn’t knowing what cards a dealer is going to place on the table. It’s understanding what your financial standing is and making the choice of calling or folding that matters.

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Fixed Rate Mortgage

The most popular or most common type of loan because of its simplicity. Interest rates are fixed over a pre determined number of years. This is also commonly referred to as 15 year or 30 year mortgage loans.

• easy to understand
• stable, outside influences like the economy do not affect the rates
• buyers can plan their monthly expenditure accordingly

• rates are comparatively higher than other loan types
• buyers don’t usually push through with long term deals

• 15 year loans are better compared to 30 year loans, as it gives the option for couples to send and plan for the future because it allows them to finish the loan in a shorter time and gives them different options for the future.

Adjustable Rate Mortgages (ARMs)

These types of loans have a lower interest rate compared to fixed rates. Rates vary in certain periods of time but the amount of movement is predetermined.

• one obvious advantage is it has lower interests rates than fixed rate mortgages
• it is also a better option for short term loans like 3 year or 5 year loans
• they are more available for buyers with larger loans
• the possibility of a lower interest rate

• interest rates vary making it harder for making a budget
• the possibility of having a higher interest rate

• be sure to check if the bank has pre-payment penalties
• negotiate with the bank for reasonable margins of interests

Adjustable Fixed Mortgages

Can also be referred to as combo loans. These are loans which start at fixed rates and then move on to adjustable rate mortgages after a set number of years.

• gives the homeowner lower interests rates to fixed rate and adjustable rate mortgages
• it is a great way of lowering interests rates and having a greater loan granted

• with a steady or fixed rate at the onset, interests rates fluctuates when the ARM takes into effect
• it would be harder to budget in the future because of rate changes

• if you have less flexibility in terms of the amount of downpayment you have and want lower interest rates, this loan type offers great possibilities.

Interest Only Mortgages

This type of loan is defined as a fixed rate loan but on the initial 5 to 7 year only interest on the loan is made. With the normal procedure for fixed interest rates applying after set period.

• a great feature of this is that you have lower monthly payments at the start which means you could save for future payments
• it gives you time to adjust and improve your financial situation before you start paying normal monthly payments

• payments made during the first years are not deducted on the principal of the loan
• there is a greater strain on the budget when monthly payments reach their normal amount

• be sure to save up while payments are relatively low. Some banks offer an option of letting you pay on the principal making for adjustments for future payments

Minimum Payment Loans

These are fixed rate plans which initially offer low interest rates at the start of the loan and increases to its normal rates after a couple of years.

• they are generally the lowest priced plans in the market
• ideal for buyers in high end markets

• potential negative amortization that increases your total borrowed amount
• after initial period ends, a threefold increase in payments is common

• you can use the minimum payment plan in the start and build up your credit position for the future

Zero Down Mortgages

Generally characterized as loans with less than 20% downpayment or zero downpayment. Designed for first time home buyers usually done with government agencies.

• for first time homebuyers or those who don’t have enough savings, this is the greatest way of acquiring that house
• this type is the most ideal for any home buyer

• requires PMI primary mortgage insurance therefore raising monthly payments
• it also limits you to the choices of houses that can be purchased

• check the nearest government agency and see if you qualify for their programs. Government rates are 0.5% to 1% lower compared to financial institutions

Balloon Mortgages

These are monthly payments based on any fixed term with 15 Yr or 30 Yr amortizations. At the end of the period, remaining mortgage loan amount will come due.

• for homebuyers who expect an increase in earnings in the years to come this would be the most ideal plan

• home value may drop with the market
• quite confusing and harder to understand for homebuyers

• this is an unpopular type of loan plan, try using more conventional plans as they are easier to understand and could provide you with better decisions

Penny’s worth

If you’re in the market for purchasing a new home, it is best that you study the different mortgage plans available on the market. Another good strategy is to check out different banks and see which could give you the best deal. This could be the most ideal time for purchasing a home, with mortgage rates at all time lows and houses at bargain prices. With the use of a mortgage loan designed for your needs, this could help you with that house you always dreamed of.

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