How To Understand Mortgage Types

By Cory Shuett, 23 Jan 21:11

The type of mortgage you need depends on the situation you are in. A good lender can tell your needs from your credit report, your assets and your employment history.

He will then recommend some options for you:

Fixed-Rate Mortgage
Interest is fixed for a certain amount of time (10, 15, 20 or even 50 years) at which point the amortized principal is paid in full. The advantage of a fixed rate is security, because you know what your payments will be. Unfortunately, you'll still
be paying the initial rate if the rates plummet.
That is, unless you refinance.

If you are keeping your home for 15 years or more, it's a conservative option. Be aware that you will pay more short-term than if you had an ARM.

Adjustable-Rate Mortgages (ARMs)
Interest rates fluctuate with an indexed rate plus a set margin, and adjustment intervals are predetermined. Minimum and maximum rate caps control the size of the adjustment.

This is popular with those who aren't expecting to stay in a home for long, who live in a hot market where houses appreciate quickly, or are planning to refinance. You can qualify for a higher loan amount with an ARM because of the lower initial interest rate. Annual ARMs have done better than fixed rate loans in the past.

It's smart to assume that the rates will increase after the adjustment period on an ARM. You are betting that you'll save enough to begin with to offset the future rate increase.

Be sure to check out the frequency of the adjustments. The more adjustments made, the lower the starting rate, but the more uncertainty. Slight adjustments mean the rate will be high, but you will have a little more security. Check the payments at the upper limit of your cap, because your rate can increase by as much as 6 percent. You can get burned if you can't afford the highest possible rate. you It's dangerous to plan on refinancing to bail you out. What if you can't qualify?

1-year Treasury ARM
The rate is fixed for one year, and then it becomes adjustable every year. The new rate is determined by the treasury average index plus the loan margin, usually 2.25-2.5 percent. The rates are lower than a fixed mortgage, and you benefit when rates go down. Watch the margin, though, as it is added to the index to come up with the new rate after the adjustment period. When rates are going up, you could end up paying more interest.
If you are a risk-taker and think the rates won't increase, this might work for you. If you are in it for the long haul, variable interest rates can mean higher payments over time.

Intermediate ARM
With an intermediate ARM, the rate is fixed for a period of time, and then adjusts on a set schedule. The number of years the loan is fixed and the adjustment interval show this. For example, a 3/1 ARM is 3 year fixed, and 1 adjustable annually. The new rate is determined by an economic index (usually treasury or treasury average index) plus the loan margin. This is usually 2.25-2.5 percent. An intermediate ARM has lower rates than a fixed mortgage. When interest rates rise, you see more ARMs because they are easier to qualify for. However, you could end up paying more interest than a fixed-rate mortgage after the initial period.

If you aren't planning to keep your house for long this might work for you, because the initial rates will be lower. Be sure to check the rate caps so you know precisely how high your payments can go.

Flexible Payment Option ARM
The borrower chooses from a variety of payment methods monthly. There is a limit on how much payments can change in a year. This frees up cash when you need it and is good for buyers with unpredictable incomes.

Some options won't cover your interest, though. With lower payments, your balance increases monthly, and eventually your payments will greatly increase. This could lead to negative amortization.

Eventually you will be required to pay down the principal and your payments will considerably increase. If you can't make them, you lose the house. Most experts would not advise this method.

Interest-only ARM
For a period of time, you pay only interest, not the principal. If you don't plan to stay in a home long, you can buy something you typically couldn't pay for. If you are in a hot market, you'll have low payments while your house appreciates. You can always pay more on the principal while enjoying low payments. One other great thing about an interest-only mortgage is that payments made to the principal reduce your monthly payment. So, if you have a job that has non-scheduled bonuses or is commission-based, you can pay the interest monthly. When you get your bonuses, pay down the principle to decrease your payment.

The day will inevitably come when you need to pay down the principal. If your home value has fallen or your income decreased, you could have trouble making payments. One strategy is to invest the difference between an interest-only loan and a fixed-rate loan to build up cash.

If you can't pay interest and principal at the same time, you probably can't afford the house. If you can't make payments, you could lose the house. If you plan to sell your house and can't sell it for what you owe, you are in trouble.

Convertible ARM
A convertible ARM can be changed to fixed rate after time. This saves on refinance costs, assuming you would have been switching anyway. However, you will have a higher fixed rate with a convertible loan. You can't look around for a better deal, but you can with a refi.

Saving the cost of the loan and the aggravation of shopping loans are a plus, but you regret it if the refinance rates are lower than your new fixed. Experts would advise you to just refinance.

Jumbo Loans
These are above Freddie Mac and Fannie Mae conforming guidelines, and therefore the big secondary lenders will not secure them. The 2006 maximum amount for a conforming loan was $417,000. When the market is good, the jumbo loans make a purchase possible, but they come with higher down payments and higher interest rates.

If you can afford the higher payments, then go for it. Make sure you in fact have enough money.

Assumable Mortgage
Assumable mortgages are adjustable-rate loans, the balance of which can be taken by a buyer. Sellers can present a low interest rate to attract buyers, but this is almost never a fixed rate mortgage. The savings might not be that much.

These loans are rare today. If the buyer who assumes the loan fails to pay, the bank will go after the original borrower.

FHA loans are assumable, but are fully assumable and are not always ARMs.

Balloon Conforming Mortgage
The interest rate is fixed for a period of time, but the principal is not completely paid back. For the remainder of the term, it adjusts to a new fixed rate controlled by the Fannie Mae net yield index plus the margin. The monthly payments are lower initially. You can save some money if your career has a good future, or you are in a hot market and plan to sell before the balloon is due. But who knows what that new rate will be? There's could be looming debt in your future.
You can refinance when the balloon comes due, but you are betting that you can afford the loan.

Balloon Mortgage
The rate is fixed for a period of time, but the principal is not completely amortized during the period. The entire principal is due as a balloon payment at the end of that period. An advantage is lower monthly payments, with the idea you can always refi or sell before the balloon.

A balloon mortgage is easy to put off. Or your life changes and your balloon pops. Refinancing costs might offset any savings you made.

Veteran Administration Loans
A VA loean is a zero-down loan offered to veterans only. The VA guarantees the loan for lenders. You pay noting nothing down and no mortgage insurance. The loan is assumable, but the rate might be higher than conventional loans or FHA loans.
Shop around first. Lenders are paid a 2 percent service fee by the government, so your points should be lower when compared to similar rate loans.

Federal Housing Administration Loans
A FHA loan is a government-subsidized loan with low down payment as little as 1-3 percent. Closing fees are included, and the government guarantees the loan. There are low rates for those who can't come up with the down payment or have less-than-perfect credit. It's great for first-time homebuyers. The loan is assumable, but if you can pay 5 percent down, you could get better rates with normal loans.

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