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| With dozens of competing lenders and mortgages to choose from, you may think that today's home loan market is terribly confusing. It really isn't though if you know the basic facts about financing a house. On these pages we will discuss the various types of loans.
Although you may see many different types advertised, they all belong to just two families: those mortgages that carry fixed interest rates, and those whose rates change during the course of the loan on a periodic schedule mutually agreed upon by you and your lender. A cousin to these loans types is the convertible which allows you to move from one type of loan to another during the course of the loan period. Here are some general descriptions for these loan types:
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- Fixed where loan interest rates stay the same for the term of the loan
- 30 year fixed the traditional loan, It offers the lowest monthly payments of fixed-rate loans, while providing for a never- changing monthly payment schedule. Some lenders offers 25, 20, and even 40-year term mortgages as well. But remember, the longer the term of the loan, the more total interest you will pay.
- 15 year fixed- allows homeowners to own their homes free and clear in half the time and for less than half the total interest costs of the traditional 30-year loan. Some homebuyers prefer this mortgage because it allows them to own their home before their children start college. Others prefer it because they will own their home free and clear before retirement and probable declines in income. The major disadvantage of a 15-year fixed-rate mortgage is that monthly payments are higher. But if saving on total interest costs and cutting the time to free and clear ownership are important to you, the 15-year fixed-rate mortgage is a good option.
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- Adjustable have become on of the most popular and effective tools for helping some prospective homebuyers achieve their dream of homeownership. Developed during a time of high interest rates that kept many people out of the housing market, the ARM offers lower initial rates by sharing the future risk of higher rates between borrower and lender.
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| ARMs can be an excellent choice of financing under certain conditions, such as rising income expectations, high interest rates, and short-term homeownership. But because payments and interest rates can increase, either steadily or irregularly, homebuyers considering this kind of mortgage need to have the income to keep up with all possible rate and/or payment changes. Each ARM has four basic components: |
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- Initial interest rate , which is typically one to three percentage points lower than that of most fixed-rate mortgages. Lower interest rates also make ARMs somewhat easier to qualify for. The initial interest rate is tied to certain economic indicators that dictate in part what the monthly payments will be.
- Adjustment interval , at the time between changes in the interest rate and/or monthly payment will be.
- Index , against which lenders measure the difference between what they are making on their investment in the mortgage and what they could be making on other types of investments. The most popular index is based on the rate of return on a one- year Treasury bill (also called T-bill)
- Margin , or the additional amount the lender adds to the index to establish the adjusted interest rate on an ARM. The margin is usually 1.5 percent to 2.5 percent.
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In addition to the four basic components, an ARM usually contains certain consumer safeguards such as interest rate caps, which limit the amount that the interest rate applied to the payments may move. This prevents the amount of interest the consumer pays from rising higher than perhaps the homeowner can afford. For instance, a typical ARM would have a two percentage point cap over the life of the loan. That means that a loan with an initial interest rate of 9.75 percent would be able to go no higher than 14.75 percent over the life of the loan, and it would be able to move no more than two percentage points per year.
Another safeguard found on some ARMs are monthly payment caps that limit the amount homeowners need to increase their payments at adjustment time. Monthly payment caps can, however, sometimes prevent the monthly payments from increasing enough to keep up with the rise in the interest rate, causing negative amortization-resulting in higher or more payments for the homeowner later on.
- Assumable - you may transfer the mortgage to a new homebuyer, usually with the same terms if the new homebuyer qualifies for the loan. ARMs are almost always assumable.
- Convertible - are another new loan product on today's market. It worked like any other ARM, but it offers homeowners a distinct advantage-it allows them to turn their ARM into a fixed-rate mortgage after a set period (usually during the second through fifth years of the loan).
- Convertible - Convertible mortgages offer today's homebuyer the option to change the loan's interest rate after some period of time or some specified movement in interest rates.
- Two step - gives homeowners the predictability of a fixed- rate and adjustable rate mortgage for a certain time, most often seven or 10 years, and then the interest rate is adjusted to fit market conditions at that time. The main advantage associated with this type of loan is that homebuyers often get a slightly lower than market rate to begin with. The main disadvantage is that they may see their interest rate go up by as much as six percentage points at the end of the seven-year period. The lender may also reserve the option to call the loan due with 30 days notice at that time, making this loan similar to a balloon mortgage in some cases.
For homebuyers who plan to stay at this property for seven to ten years, this type of loan presents an excellent way of getting a fixed- rate loan at a better than market price for a fixed period of time.
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- Lender buydown - where the homebuyer gets an initially discounted rate and gradually increases to an agreed-upon fixed rate over a matter of three years. For example: When the market rate is 10 percent, the fixed rate for the mortgage is set at about 10.5 percent, but the homebuyer makes monthly payments based on a first year rate of 8.5 percent. The second year the rate goes up to 9.5 percent, and for the third year through the remaining life of the loan, the rate is calculated at 10.5 percent. A second type of lender buy-down, called a Compressed Buydown , works the same way, but with the interest rate changing every six months instead of on a yearly basis.
The Lender Buydown gives consumers the advantage of lower initial monthly payments for the first two years of the loan when extra money may be needed for furnishings and, secondly, the advantage of knowing that, although the interest rate does change during the first three years of the loan, the interest is fixed from the third year on.
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- This new type of loan offers homeowners the option of getting a loan that , under the right conditions, can be adjusted to a lower interest rate with a payment of $100 or $200 or so and a small loan amount-based fee, sometimes as little as one-fourth of a percentage point. These conditions usually are a prescribed movement in rates-typically two percent below the initial- during a set time limit-between months 13 and 59, for example.
On a 30-year fixed-rate mortgage with a reduction option, the homebuyer pays an extra one-fourth to three-eighths of a percentage point in the interest rate on the mortgage plus a quarter to three-eighths of 1 percent of the loan amount (points) at the time of closing. This allows the homeowners to adjust the interest rate on the loan without having to go through a refinancing, which could cost up to 5 percent or 6 percent of the loan amount, if the rates are right during the prescribed time limit.
On an $80,000 loan, this means that you could reduce the interest rate on your loan from, say, 10.5 percent to 8.5 percent, and take advantage of the low rates for the rest of the loan term for $150 instead of up to $4,800 , if the rates dropped to that point during your "window of opportunity" - months 13 through 59. Some homeowners may find the ROL a good "insurance policy" against the high costs of refinancing. Others may want the flexibility that refinancing offers - namely the ability to draw on built-up equity- that is not available with ROLs. The decision is up to you
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Now that you have a general understanding of the loan types, let's look at some of today's popular loans:
100% financing (Zero Down) This loan piggybacks a second loan onto your first mortgage so that you can finance 100% of your home without a down payment or having to pay for PMI. This is usually an 80/20 loan where first loan covers 80% of the purchase price and the second, or piggyback loan, acts as a down payment covering the remaining 20% of the purchase price. The second generally comes with a higher rate and a shorter term. Only single-family homes that will be owner occupied are eligible.
80/15/5 - This is a loan which carries a second mortgage for up to 15% of the purchase price of the property. It is usually used when wishing to avoid PMI insurance or to keep your first mortgage under the FNMA/FHLMC limit to avoid Jumbo rates. The borrower puts down a 5% down payment and then finances a first mortgage up to the FNMA/FHLMC limit and a second mortgage of up to 15% of the purchase price. Other variations are 80/10/10 or 75/15/5.
Reverse Annuity Mortgage (RAM) - For older Americans, especially retirees living on fixed incomes, the equity in their paid-for or almost-paid-for home represents a large but liquid asset. The RAM is designed to help supplement those homeowners' income.
The lender who will issue a RAM appraises the property and makes the loan based on a percentage of its current value. The homeowner retains ownership, and the property secures the loan. The lender then pays an annuity to the borrower, usually on a monthly basis, up to an amount equal to the equity they have in the home.
The advantage of such a loan for older Americans is that of receiving a monthly tax-free income. Under one plan, this income is available for life or until the house is sold as the homeowner moves. The schedule of payments depends on the value of the home and the ages of the owners. There are risks involved, however. If the homeowner wants to move and buy a new house, there may not be enough equity in the home to permit such a plan. Or the lender may consider only the current market value of the home rather than any future appreciation when deciding on the monthly payments.
Home Equity Lines of Credit These stand alone seconds allow you to borrow against your equity rather than refinancing. With a line of credit you won't have to make any payments until you begin to spend the money in the account. Plus, you only pay interest on the outstanding balance, not on the total amount available. This is a great way to improve your financial situation or generate a quick amount of cash to pay for renovation or other purchases. Lines of credit typically come with adjustable rates.
Kiddie Condo this type of mortgage allows a person to co-borrow with a blood relative (eg. parent, grandparent, sibling, etc.) who helps qualify for the loan using their income or assets. Both borrowers take title to the property and sign for the loan. This is a great way for a college student, recent graduate, or anyone unable to obtain a loan on his/her own to buy a property with the help of a family member and establish a solid credit rating. Plus, interest rates for Kiddie Condo loans are lower than those for investment properties. Generally available as a 30 year fixed or 1 year ARM.
Interest Only a loan where you pay only the interest on your mortgage for a fixed period of time. Once that period of time expires, the unpaid balance is fully amortized over the remaining term and the borrower is now obligated to make principal and interest payments to the lender. This loan will help you get into a home with lower payments however many people have difficulty adjusting to the large payments when the initial term expires.
3/1 Intermediate ARM this loan provides a low fixed rate for a period of three years. After the initial fixed period, these loans typically adjust to the current rate and adjust annually for the remainder of the loan term. These loans are popular with borrowers who want the stability of a fixed rate and the benefit of a lower introductory rate. If you plan to sell or refinance your property in the next three years, you might want to consider this loan over a fixed rate mortgage. The disadvantage of this loan is that you risk having a higher rate if you are still in the property when the introductory rate period expires. Other variations are 1/1, 5/1, 7/1 and 10/1. Also known as a 3 year arm.
These are just a few of the loan options available to you. Give one of our agents a call to discuss your financial needs.
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