When you make your monthly mortgage payment, part of it goes to pay the bank its interest, and part of it is used to pay off the loan. At least, that?s how it used to work. Some banks have now introduced a new type of loan to attract more borrowers by keeping the monthly mortgage as low as possible by only paying the interest.

The borrower can pay whatever amount he prefers, as long as he pays the minimum payment of the interest due each time. Even with more conventional home loans, you could pay extra on your mortgage to pay down the principal balance faster, but the idea of this loan is to keep the monthly payment down.

Interest only loans were predicated on the theory that it doesn?t matter that the principal was never reduced, because when the house was sold, the additional value would allow the borrower to pay off the loan. The combination of increased equity due to market increases, and the paydown of the principle guaranteed most borrowers some residual value in the home when sold.

Today?s falling home prices means that homeowners can no longer depend on an automatic increase in their house?s value. There may be some instances where interest only mortgages can work. But it should really only be used as a temporary solution.

Suppose, for example, that a couple bought a house at the time when one of them was employed and one of them was still studying. Since, in theory, the student would eventually complete his studies and get a good job, keeping the home loan payment low during this period and ramping them up later makes sense.

Another valid situation might be if the primary income owner had an erratic salary pattern, in which he had little to no income for a period and then a windfall income. Such an example might be a project worker who is only paid when the project is complete. It would be in his best interest to maintain his home loan payments low during the periods of no income and increase them when the large income was received.

But in any of these cases, the homeowners cannot count on the value of the home rising and should make sure principal payments are made. You want to make sure that you pay down some of the principle so that you will have some equity put in the home, since you can no longer count on real estate market increases to do it. If the owner only pays interest, the loan balance never goes down, so if the owner sells in today?s market of falling prices, he may not receive enough to pay off the mortgage.

When you are attempting to time the best entry point to borrow for your home, picking a time when interest rates are down will save you a lot of money. Will interest rates go up, in which case you should lock in a fixed interest home loan for as long as you can, or are they headed down, which means you should either wait to buy or refinance, or choose a rate that adjusts frequently?

How are these interest rates fixed in the first place, and will understanding that help in the decision making process? If you regard interest rates as the price of money, and understand that factors like supply and demand influence all prices, you can see how the ?price? of money can even affect your mortgage.

The most important predictor of interest rates is inflation. Inflation is measured by two important indicators called price indicators. The Producer Price Index and the Consumer Price Index are the main two factors.

PPI is the fluctuation in prices at the level where goods are produced. Increases in the Producer Price Index gives us higher prices for finished goods, and that means inflation.

The Consumer Price Index (CPI) measures changes in prices of a fixed ?market basket? of consumer goods. CPI is more well known to most people because it indicates whether the prices we are paying are rising or falling, and by how much. Frequently, to remove some of the volatility of the CPI, analysts examine core inflation, which eliminates energy and food prices from the formula. This allows them to look at the core inflation rate to better analyse where overall prices, and therefore inflation, are heading.

GDP or Gross Domestic Product also predicts inflation and consequently interest rates. Central banks try to foster slow, steady growth in the economy, since zero growth means recession, and too fast growth will lead to inflation. Central banks intervene in the money markets to influence the supply of money to slow the economy down or speed the economy up.

Another important indicator is the unemployment rate. If the economy is experiencing low unemployment, inflation will probably follow since salaries have to increase to bring in candidates. High unemployment will typically lead to lower interest rates since it means lower wages and consequently lower prices. In other words, increased wages lead to a wage price spiral and lower wages bring prices down.

The prospective home buyer can help himself by keeping an eye on these indicators to attempt to determine rates. The bigger picture to watch out for is a lower GDP with unemployment which leads to lower rates. Increasing GDP and low unemployment means the economy is heating up and you can expect higher interest rates in the future.

Worrying about what kind of mortgage you want to take is hard enough, without also deciding on which interest rate index is going to be the deciding factor on what your interest rates on your Adjustable Rate home loan will be!

When we speak of the “index”, we are talking about of the base financial instrument that the changing rates will be based on. These indices may be such instruments as the T-Bill rate, the rate of Federal Funds, or rates based on LIBOR.

The basic concept of an ARM is that the interest on the loan is adjusted up or down, on a periodic basis, based on a chosen underlying interest rate that is indicative of interest rates in general. One such instrument would be Certificates of Deposit-your mortgage rate would go up and down with the CD rate. ARMS also contain adjustment caps, so that you can limit the exposure as to how high your loan rate can go, even if your index rate continues to go up, which is good if you just had a change, and the rates increase again. This can be a disadvantage if you have just readjusted, and afterwards there is a downward movement, however.

ARMs can be tied to a lot of underlying instruments, for example the 90 day U.S. Treasury Bill. The Fed Fund rate is the rate banks pay to the Federal Reserve Bank to borrow money. LIBOR, the London Interbank Offered Rate, is another popular index, and is the rate used by international companies to borrow.

Deciding upon which index is best for you will depend on your own situation as well as your view of interest rate movements. Adjustable rate home loans that use CDs as the reference rate tend to change more quickly. Adjustable rate mortgages that use T Bills tend to change more slowly. LIBOR is one of the quickest moving indices, so if you want to take advantage of rapidly falling interest rates, this is the one to use.

An option ARM is one in which the interest rate adjusts monthly and the payment adjusts annually, and the borrower is offered an “option” on how large a payment he would like to make. The options that are offered represent interest-only payments, and a lowest possible payment that can’t be less than the interest-only payment. Those using this option should be aware of negative amortization, because they may never repay any of the principal if they always choose the lowest amount.

There are so many choices in the home loan market today that the new home buyer should not try to cover this field by himself but should instead call a certified mortgage consultant.

There is not a great deal of difference between first and second mortgages except that one is normally taken out when a home is bought, and the other is taken out on the remaining balance of the first mortgage.

Second mortgages are usually obtained to perform some sizeable improvement to the home, but frequently homeowners decide to use the increased equity in their property to take out a second mortgage and pay down consumer debt.

A home improvement is a good reason to take out a second mortgage, but you should make sure that the improvements you make are going to perform are worth the added payments you will be making.

Taking out a second mortgage to install an in ground pool may not be the best use for the funds, since a luxury item like this may not necessarily add to the value of a home.

Reducing high interest rate debt is another good use for a second mortgage, as long as you are able to keep your overall costs down. Typically, a homeowner would be interested in paying down consumer debt, such as credit card debt that may have interest rates of 16-20% with the proceeds from a second mortgage, which may have a rate of 5-9%.

But to take out a second mortgage that it not going to give you either of these ends-add value to the home, or save money on consumer debt- is not a good choice.

Since a first mortgage is paid off from the proceeds of the home in case of default, there may not be enough equity in the home to pay the second mortgage, and this is the risk the second mortgage lender takes.

For this reason, rates on second loans are higher since the bank has that risk, and the chance of default is higher.

Second mortgages have closing costs, so you should be aware of them and make sure that they do not make the second mortgage so expensive that it will not balance out the savings you envisioned.

It really pays to shop around for a second mortgage, since the rates can vary widely. You should also shop around for the lowest closing costs. Closing costs for a second mortgage are a proportionately greater expense since the loan is typically for a smaller amount than a first mortgage.

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Once you start considering the purchase of a home, the first thing you may worry about is how good a rate you will get.

And once you know how those rates are determined, is there something you can do to get the best rate for your homeloan?

One of the most important factors, and one that keeps hitting the news all the time today, is your credit score. This is an issue that is in the headlines all the time, and everyone who is looking to purchase a home is concerned about their “FICO” numbers.

The concept, in a general way, is fairly simple. Agencies rate you for lending institutions to let them know whether or not you are a good risk to lend money to. If you have high income, with a steady job, and have never had any problems paying back any loans, you will have a high FICO score.

One of the most important factors that will influence a loan rate is the size of the down payment.

First of all, you are putting your own funds into the project; this gives the bank confidence that you are confident enough in paying back the mortgage that you have committed sizeable upfront funds as a down payment.

Consequently, the higher the deposit you are willing to make, the better the rate will be deposit. If you consider that your rent payments could be mortgage payments building equity if you had a home, you would want to buy as quickly as possible.

The “term” of the mortgage is also an important component in how rates are determined. If a bank has to commit for a longer period, they are going to price that additional exposure into the loan rate.

Taking a shorter maturity on your mortgage, such as a five year loan instead of a 25 year traditional loan will result in a lower rate for you. The downside to this concept is that, if rates are on the rise, you will have to pay more each time you renew your five year mortgage, instead of having a steady rate for 25 years.

This is one of the other important factors in what determines interest rates: What the general market is doing. If interest rates are going up in general, interest rates on mortgages will go up as well, since banks have to pay interest on the money they obtain. Complex economic gauges are at the root of the fluctuations in interest rates.

But the same as rates go down as well as go up, many people prefer to have a longer term fixed rate.

A final factor is the size of your mortgage. Banks have limits as to the size of the home loans they can write, and a borrower who requires a higher mortgage than that, even if they have the income to support it, will most likely pay a higher rate.

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If you are shopping for a mortgage, you of course want the best possible rate. This is a decision that you will live with for many years. How do the banks determine the rate they quote you in the first place?

There are some factors that determine the interest rate that you can control, and some that are completely out of your control. It is a good idea to know the difference.

The first and foremost determinant of the interest rate on a loan is the credit worthiness of the borrower. You may have observed internet advertisements concerning credit ratings, or heard talks about a credit score, often called a FICO score.

If you have wondered what a FICO score is, it is a number that credit companies assign to a person’s credit status. If you have high income, with a good job history, and have never had any problems paying back any loans, you will have a high FICO score.

One of the most important factors that will influence a loan rate is the size of the down payment.

The higher the deposit, the better the rate you will receive from the bank; this is because with a higher down payment, the bank has less exposure based on the value of the property.

So a higher down payment will result in a lower rate. If you consider that your rent payments could be mortgage payments increasing equity if you had a home, you would want to buy as quickly as possible.

The next factor that will be used to determine the rate is the length of the loan. If a bank has to commit for an extended length of time at a fixed rate, they will want to protect themselves by making the rate higher.

This is why you will typically see short term loans at a lower rate than a 25 or 30 year mortgage. However, many people still prefer to negotiate a longer term loan if they can because they fear that interest rates will rise and they will constantly have to renew their home loan at a higher rate.

This is one of the other important factors in what determines interest rates: What the general market is doing. Since lending institutions have to borrow on other markets in order to lend mortgage money, the cost of their money goes up and down. These market rates are set according to complex economic indicators.

Most people would rather take a chance on a fixed rate that can’t go up, than a rate that changes periodically. Even if rates go down, they feel the risk is better to have a locked in rate than a changing rate.

A final factor is the size of your mortgage. Banks have limits as to the size of the home loans they can write, and a borrower who requires a higher mortgage than that, even if they have the income to support it, will most likely pay a higher rate.

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Unless you have been in the mortgage market for some time, you may not be sure about the concept of discount points. It is a simple enough concept: in order to lower the interest on your loan, you pay your bank some cash upfront as an incentive to lower the rate. When the rate is less, so will the monthly loan payment.

One point is a cost equivalent to 1% of the total amount of the loan. For a $200,000 mortgage, one point costs $2,000. The more points you are willing and able to pay, the lower the rate on your mortgage will be.

Your home loan rate is calculated primarily by your credit worthiness, but whatever the rate on the loan, paying points will make it lower. For example, if your original rate quote is 6%, according to your credit score, ask how much it will be if you are willing to pay any points. A general rule, but one that can change from one lender to another, is that one point will lower the loan rate .25% on a fixed rate loan and .375% on an adjustable rate loan. In the case of your $200,000 home loan that you are willing to pay $2,000 for one point, your mortgage would then be reduced to 5.75% for a fixed rate loan and 5.625% for an adjustable rate mortgage.

If you inquire about a mortgage rate, you will most likely see the rate quoted with the points. For example, the bank may list the rate as 6%, no points, 5.75%, one point, 5.5%, two points, etc. Next you would see 7%, with the accompanying rate reductions per point, and so on for each rate. This is why it is necessary to know your original rate and then calculate the reduction for points.

Obviously, your loan payment is going to be lower on a loan with 5.75% or 5.625% than it will be on a loan with a 6% rate. Lowering the rate like this is because you are really paying some of your interest beforehand. If you only held onto the loan for a short while, after you sell the house or refinance, you will have paid this interest for a loan you no longer have. In other words, you have to amortize the payment amount for the points over how long you plan to have the loan.

Many times home sellers employ points to get buyers. A seller may advertise “seller pays points” to bring in more buyers. But this shouldn’t change the original calculations, because the price of the house will reflect the seller’s contribution.

Borrowers do not have to pay points, they do it if they are interested in reducing the rate. It’s a decision that a borrower can examine depending on all of the other factors in the loan.

Many borrowers are not aware, but they can choose a payment option for their mortgage that makes it easier to pay because it suits their needs. If a borrower can suit the payment method or schedule to his needs, his loan history will be better.

Suppose you are one of those who never pays his home loan on time simply because you are too busy; you could use online bill pay or you could have an automatic bank deduction. Of course, you still have to be sure you have the money available, but if that is not an issue, and you are usually late simply because of not having the time to sit down with your checkbook, these are ideal solutions.

You may even find that many banks are able to offer a lower rate if your mortgage is automatically deducted from an account you hold with them. Their processing costs are lower, and they are guaranteed that the loan will be paid, so they can pass some of those savings on to the borrower.

One of the most common problems many wage earners have is to keep the money available for when the mortgage is due. Even when you try to set one half of the mortgage aside with your first paycheck, you may find the amount dwindling when the check is due. Many homeowners would rather to pay half their home loan at the start of the month, and the other half at the middle of the month.

In this manner, they can match the payment due dates with their biweekly paycheck and assure that this major expenditure is covered before other non essential items may eat away at the balance in the checking account. An added advantage is that the borrower will lower his mortgage more quickly by paying half the payment two weeks early each month.

Banks also give option loans that let the borrower decide how much he wants to pay. This convenience can be dangerous if it is not managed properly. There is normally a minimum amount due which is the amount of the interest due, and then the homeowner pays anything (or nothing) above the interest. However, only remitting the minimum means that the loan balance is never paid.

If, however, you earn an income that fluctuates greatly, perhaps as a salesman or consultant, you may want the flexibility of keeping payments low when funds are low and catching up when quarterly sales bonuses come in. This will only be good for those individuals who have enough discipline to pay the larger amount when the money is available.

Banks have been cutting their home loan portfolios back, that is certain, but the careful borrower can still locate a mortgage.

Many local banks never got involved in the credit mess and are actively lending. That small banks are performing this task should not be too much of a surprise. The beginning of the home loan business was really small building and loan societies that funded local expansion with local investments. Of course, they go by other names nowadays, but lenders that focused on their core business and area have largely avoided many of the problems in banking.

They are actively granting loans to their customary clients and even expanding to pick up the slack where other banks are no longer active.

While major banks project lower loan volume in all categories, including mortgages, community banks expect stable numbers in loan volume for single family homes, but no increases.

But there are still many organizations, community-development banks, credit unions, and other entities that are not only still lending, but lending to sub prime customers, because they are involved in shoring up the communities they are located in. These banks are not just managing, they are thriving.

Organizations like Chicago’s Shorebank, which has $2.3 billion in assets and predominantly serves low income communities boasts a delinquent loan rate of 3.1% of assets, compared to the national average of 18.7%. They do lend at increased rates than for prime rate customers, but they are careful about their risk. They strive to be profitable, but not to be involved in “profit maximizing” according to Mark Pinsky, CEO of Opportunity Finance Network, an umbrella group for community development finance institutions. If we take profit maximizing as a euphemism for greedy, then this may be one of the main things that separates these banks from the national giants that are on the ropes now.

If you look at the salary of a CEO of one of these small community based organizations, such as that of Douglas Bystry of Clearinghouse CDFI, at $190,000 in comparison to that of Angelo Mozilo, CEO of Countrywide Financial at $22.1million, you can see a problem. ShoreBank is located in an abandoned 1920’s movie house, not a multilevel steel and granite structure in a suburban corporate park.

These kind of lenders prefer to remain close to their customer base, for by doing so, they can monitor their loans and protect their assets better. For example, Shorebank has an interesting energy program that assists and encourages bank clients to lower their heating bills, making money available to pay the mortgage!

Banks have been cutting their mortgage loan portfolios back, that is for sure, but the careful borrower can still locate a mortgage.

Smaller, community based banks are still extremely active in the mortgage business. That small banks are doing this should not be too much of a surprise. The origin of the home loan business was small, locally focused “building societies”, who took in deposits from local citizens to lend out to local homebuyers. Of course, they go by other names nowadays, but lenders that focused on their core business and area have for the most part avoided many of the problems in banking.

They are still able to not only make mortgages available, but are even expanding their mortgage portfolios to fill some of the gap created by the big players who have been forced out of the market because of rapid expansion in low quality loans.

The large, stamdard banks are cutting back on loans across the board, but local, community based banks are predicting continued stability in their lending business, although with not much growth.

Community lenders such as this, that may include credit unions and development banks, have had extraordinary success in lending to the so-called sub prime borrower, because they stay close to the customer they are lending to. In fact, many of these lenders are not just staying alive, they are earning a profit.

A good example is Shorebank of Chicago, a $2.3billion asset bank which is active in the low income community of this city and, compared to the national average of delinquencies of 18.7%, has only 3.1%. Since they are dealing with sub prime customers, their rates are higher, and they tend to be extremely careful about how they manage their loans. They strive to be profitable, but not to be involved in “profit maximizing” according to Mark Pinsky, CEO of Opportunity Finance Network, an umbrella group for community development finance institutions. Reading between the lines, profit maximizing can be understood to represent the greed that has been one of the foundations of the financial markets’ current woes.

If you look at the salary of a CEO of one of these small community based organizations, such as that of Douglas Bystry of Clearinghouse CDFI, at $190,000 in comparison to that of Angelo Mozilo, CEO of Countrywide Financial at $22.1million, you can realize the problem. ShoreBank is located in an abandoned 1920’s movie theater, not a multilevel steel and granite structure in a suburban corporate park.

These kind of lenders prefer to remain close to their customer base, for by doing so, they can monitor their portfolio and protect their assets better. Take the program managed by Shorebank that educates its borrowers in energy conservation in order to save costs, money saved that can contribute to paying the mortgage.