Do homework before choosing home loan

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Dear Dr. Don,
We are first-time homebuyers looking at a foreclosed home worth about $50,000. We have a somewhat small budget and can only make a small down payment of $1,000 or less (more like $500). We were told we should go with a 30-year, interest-only fixed-rate home loan, since we need small monthly payments and intend to sell it in probably five to 10 years.

I have no idea what to do and need advice on what home loan we should get to fit our budget/down payment and who we should go through — a bank, lending company, etc.? Please help!
— Matt Mortgage

Dear Matt,
My first reaction is that someone who only has $500 to $1,000 for a down payment on a house shouldn’t be buying a house, even if it’s a really great deal. Even with an FHA loan, you’re expected to make a 3.5 percent down payment, or $1,750 on a $50,000 home. Closing costs will raise the total by another 2 percent to 3 percent, although you may be able to finance part of the closing costs.

The home mortgage market is reeling from no-money down loans made in the past few years, so lenders aren’t looking to add more to their books.

If you have money saved in an IRA account, taking advantage of the first-time homebuyers’ provision for these accounts will allow you to withdraw up to $10,000 without paying the 10 percent penalty tax. You may also be able to borrow money against your 401(k) or 403(b) account.

I’m not sure you need an interest-only 30-year fixed-rate loan. The difference between the interest-only payment and the fully amortized payment (principal plus interest) would be about $60 a month. The typical interest-only loan becomes a fully amortized loan after a period of time, generally after five to 10 years, and your payment will increase accordingly even if you have a fixed interest rate.

It’s common for an interest-only loan to have a higher interest rate than a comparable conventional loan. That interest differential would reduce the monthly savings from the interest-only option.

You can use Bankrate’s compare rates feature to find today’s mortgage rates for conventional and FHA loans. Forearmed with this knowledge, you don’t really need to work with a mortgage broker to shop rates.

If you decide to work with a mortgage broker, I’d suggest an “upfront mortgage broker,” as discussed by The Mortgage Professor, Jack Guttentag, in the Bankrate feature “Want your mortgage wholesale? Try an upfront broker.”

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