Mortgage Smarts: Know What You're Getting

Getting caught off-guard by restrictive mortgage terms that your lender didn't warn you about can be disastrous. Avoid this fate by learning what to look for in your loan documentation.

Opening presents on your birthday is great fun, except when you misjudge what's inside the box. When the box that looks like it holds the watch you've been eyeing actually contains specialty paperclips, you're going to be disappointed. Now, imagine how you'll feel if you make a similar misjudgment on your mortgage loan.

Recent events in the mortgage industry tell a chilling tale. Borrowers around the country are facing foreclosure because they were duped. Maybe they were lied to, or maybe their lenders-in their haste to get the deal done-were deliberately or unintentionally silent about certain loan terms. Either way, the result is serious financial turmoil.

Mortgage documents 101

Reading and understanding all your mortgage documentation is the best protection against funding a bad loan. If you don't know where to start, look for these items in particular:

• Interest rate. Find the value and the definition of your mortgage rate. If it's fixed for the life of the loan, you need to verify that the number is what you had expected. Confusion often arises when the rate is described as being fixed, but for a time period shorter than the life of the loan. To dispel the confusion, any loan structured in this way is an adjustable-rate mortgage (ARM). In this case, you need to know the earliest date on which the rate can change, as well as how often the rate is reset thereafter, and what the maximum adjustment amount is. Use a mortgage calculator to determine how high the payments could potentially go.
• Prepayment penalties. This potential hefty expense can blindside you when you're trying to refinance. Know what they are, when they're applied, and how they're calculated. If you think it's likely that you'll need to refinance and incur these penalties, ask your lender for a rate quote on a loan that has no penalties.
• Pay-off schedule. Locate the section in your loan documentation that discusses amortization. A fully amortizing loan will be completely paid off on the date the loan matures, as long as you make your scheduled payments. Other loans might strap you with a large payment due at maturity; typically, you'd have to refinance that amount. Even worse, some ARMs incorporate a scary thing called negative amortization, which causes your loan balance to increase over time. If you're allowed to make a payment that's lower than your monthly-accrued interest, your loan has negative amortization; the amount of interest that isn't covered by your payment will be added into your loan balance.

Don't put your signature on any dotted line until you know exactly what the future holds for you and your loan. It's the right thing to do-and the only way to avoid bad mortgage loan surprises.