Checklist:
Home purchase contract terms and clauses
When a purchase contract is set before us, many of us may find our eyes glazing over. While the prospect of combing through a contract may be unappealing, there are key points everyone should be sure to understand. Here are some common terms and clauses in a purchase contract. Clarify with your realtor if there is anything you do not understand.
- Name of buyer(s) and seller(s). It seems obvious, doesn't it? If you are the buyer, make sure to fill in your name as you would like it to appear on the deed. If there is more than one buyer, list the names of all co-buyers.
- Legal description of the property. Make sure the description is specific, particularly regarding city limits, school districts and rural properties, and include any relevant zoning information as well.
- Down payment or deposit information. Often, a buyer will offer a deposit (usually $1,000 or one percent of the purchase price) with an offer. This amount should be held in escrow (by an attorney or a realtor's trust account) until all conditions of the contract have been met.
- Purchase price. Both parties will negotiate the amount until an agreement is reached. The contract should list the final agreed-upon price, as well as the exact terms of sale.
- Closing date. This is the date the deed will change hands. If you are the buyer, it is the date the home will officially become yours. If you are the seller, you will need to move out by this date.
- Personal property included in the sale. This includes any appliances, furniture or other items included in the contract. Include a detailed description of all personal property items, including the make and model of any appliances.
- Disclosure of defects and lead paint disclosure. Some states, such as California and Maine, require the seller to disclose any known defects about the property in writing. If the house was built before 1978, the seller is required to include a lead-based paint disclosure as part of the contract. If the property was built after 1978, this disclosure becomes optional.
- Contingencies. If the sale is dependent on the buyer's mortgage financing, the details of the financing should be included in the contract. The buyer can even list things such as expected interest rate and mortgage terms.
- Inspections. An acceptable property inspection should be a condition of sale. If there are other, specialized inspections to be conducted (such as a termite inspection), they should be listed here as well. Include a clause that indicates who takes on the cost of repairing problems found during the inspection process -- the seller usually assumes the cost of major repairs.
- Home warranties. If a home warranty has been purchased, information should be included in the contract.
- Title insurance. Information about title insurance should be listed in the contract. There should also be a clause identifying how to handle potential problems that arise during the title search.
- Commission information. The contract should stipulate who pays the agent's commission, and how much gets paid.
- General contingency clauses. Some contracts include a general clause that allows the buyer a few days to review the agreement with an attorney or other professional.
- Signature. This is the famous dotted line. Both the buyer and seller should sign only when they are comfortable with all terms in the contract.
- you are planning to stay in your home for several years.
- you want the security of regular payments and an unchanging interest rate.
- you believe interest rates are likely to rise.
- you are planning to be in your home for less than three years.
- you want the lowest interest rate possible and are willing to tolerate some risk to achieve it.
- you believe interest rates are likely to go down.
- you would like the peace of mind that comes with a consistent monthly payment for three or more years, with an interest rate that's only slightly higher than an annually adjusted ARM.
- you are planning to sell your home or refinance shortly after the fixed term is over.
- you want flexibility because you have a fluctuating income -- for example, if you're self-employed or work on commission.
- you are financially disciplined and won't be tempted to simply pay the minimum every month.
- you are buying a home with the expectation of an improvement in your financial situation -- for example, you have a large debt that will be paid off in a few years.
- you want to stay in your current home but are experiencing a temporary financial squeeze -- for example, you are going back to school, or taking a few years off to stay home with your children.
Finding the best mortgage for you
One of the most important steps in buying a home is determining what kind of mortgage is right for you. After all, a mortgage is a financial commitment that will last for many years. Make sure you select a mortgage that matches your risk tolerance and financial situation.
Fixed-rate mortgages
With a fixed-rate mortgage, the interest rate and monthly payments stay the same for the life of the loan.
These mortgages are usually fully amortizing, meaning that your payments combine interest and principal in such a way that the loan will be fully paid off in a specified number years. A 30-year term is the most common, although if you want to build equity more quickly, you might opt for a 15- or 20-year term, which usually carries a lower interest rate. For homebuyers seeking the lowest possible monthly payment, 40-year terms are available with a higher interest rate.
Consider a fixed-rate mortgage if:
Adjustable-rate mortgages (ARMs)
With an adjustable-rate mortgage (ARM), the interest rate changes periodically, and payments may go up or down accordingly. Adjustment periods generally occur at intervals of one, three or five years.
All ARMs are tied to an index, which is an independently published rate (such as those set by the Federal Reserve) that changes regularly to reflect economic conditions. Common indexes you'll encounter include COFI (11th District Cost of Funds Index), LIBOR (London Interbank Offered Rate), MTA (12-month Treasury Average, also called MAT) and CMT (Constant Maturity Treasury). At each adjustment period, the lender adds a specified number of percentage points, called a margin, to determine the new interest rate on your mortgage. For example, if the index is at 5 percent and your ARM has a margin of 2.5 percent, your "fully indexed" rate would be 7.5 percent.
ARMs offer a lower initial rate than fixed-rate mortgages, and if interest rates remain steady or decrease, they may be less expensive over time. However, if interest rates increase, you'll be faced with higher monthly payments in the future.
Consider an adjustable-rate mortgage if:
Hybrid mortgages
A hybrid mortgage combines the features of fixed rate and adjustable rate loans. It starts off with a stable interest rate for several years, after which it converts to an ARM, with the rate being adjusted every year for the remaining life of the loan.
Hybrid mortgages are often referred to as 3/1 or 5/1, and so on. The first number is the length of the fixed term -- usually three, five, seven or 10 years. The second is the adjustment interval that applies when the fixed term is over. So with a 7/1 hybrid, you pay a fixed rate of interest for seven years; after that, the interest rate will change annually.
Consider a hybrid mortgage if:
Option ARMs
Also called "flex ARMs" or "pick-a-payment mortgages," these are adjustable-rate mortgages with a twist. Each month, rather than paying a set amount, you'll receive a statement with up to four payment options ranging from a small minimum to a fully amortized payment. You select the amount you want to pay each month.
Option ARMs entice borrowers by offering initial low minimum payments, but after an introductory period, the required minimum rises substantially. In addition, if you choose the minimum payment option too often, you won't build equity in your home and may even end up increasing your loan's balance.
Consider an option ARM if:
Interest-only and balloon mortgages
Unlike an amortized mortgage where you pay a combination of interest and principal each month, with an interest-only mortgage you pay only interest for a fixed period -- usually from five to 10 years. This means the principal never goes down, and after this period has elapsed you have to either pay the entire principal off or start paying down the principal, which results in much higher monthly payments.
Balloon mortgages also offer low regular payments for a number of years (often just slightly below what you'd pay for a 30-year fixed rate mortgage). After this fixed period, the principal must be repaid as a lump sum, which generally means refinancing. Because very little of the principal has been paid down, once again, your payments will increase.
These loans can be helpful temporarily, but they don't allow you to build equity in your home, and they can cause serious financial strain when the principal comes due.
Consider an interest-only or balloon mortgage if:
The details
Once you know what type of loan is right for you, look at the specifics. First, of course, is the interest rate. Remember, however, that the rate you're offered may not tell the whole story. Are there closing costs, points or other charges tacked on? Make sure you ask for the loan's annual percentage rate (APR), which adds up all the costs of the loan and expresses them as a simple percentage. Lenders are required by law to calculate this rate using the same formula, so it's a good benchmark for comparison.
The features of your loan -- which may be buried in small print -- are just as important. A favorable adjustable-rate loan, for example, protects you with caps, which limit how much the rate and/or monthly payment can increase from one year to the next. Ask whether a mortgage carries a prepayment penalty, which may make it expensive to refinance. And don't be seduced by low monthly payments -- some of these loans leave you with a large balloon payment due all at once when the term is up.
Source: Ginnie Mae
Click here for the Ginnie Mae Mortgage Affordability Calculator
