Types of Mortgage Loans
Fixed Rate Mortgages: Loans are amortized over a 10, 15, 20, 25, 30 and 40 year terms. Monthly payments and interest rate remains the same over the entire life of the loan. Advantages and disadvantages of each:
30-Year Mortgage Loan: In the first 23 years of the loan, more interest is paid off than principal, meaning larger tax deductions. As inflation and costs of living increase, mortgage payments become a smaller part of overall expenses.
20-year Mortgage Loan: Interest rates are usually much lower than 30 year mortgage loans and can save a considerable amount of interest costs since mortgage is paid off 10 years earlier.
15-year Mortgage Loan: The mortgage loan is usually made at a lower interest rate. Equity is built faster because early payments pay more principal. Interest savings are significant when compared to a 30-year loan. Ideal for those close to retirement age. If you have a fixed rate loan and the interest rate drops significantly, you may want to refinance. Experts are in agreement that refinancing is a smart move if you can get an interest rate that is 2 points less than your current rate and you plan to remain in the house for at least 18 more months (to recover costs associated with refinancing).
Adjustable Rate Mortgages (ARMs): The interest rate and monthly payment remains the same for a fixed period (1, 3, 5, 7 or 10 years) and then the rate can rise at fixed intervals. This increase can be anywhere from .05 to 2.00 percent per increase. There is a cap on the margin that determines the highest rate the interest can go. The major advantage of this type of loan is that home buyers can get a lower rate for a certain period of time, and then refinance when fixed rates get better. Consumers are drawn to these types of loans because (1) they usually offer a lower initial interest rate than a fixed mortgage, and (2) the lower interest rate may qualify many consumers for a larger loan.
Fixed rate vs. ARM: Fixed rate mortgages are predictable since the monthly payment never changes. Since the monthly payments associated with ARMs are lower in the beginning, they make home ownership more affordable and may allow borrowers to qualify for a larger loan; however, one should make sure that his or her income will increase in the coming years per the cap set in the mortgage agreement. ARMs are also a good idea for those planning to sell their home in the next few years since increasing interest rates won't affect these homeowners.
Balloon Loans: Balloon loans offer a lower interest rate for a period of 5, 7 or 10 years. At the end of the term, a lump sum payment of the outstanding balance is due or you must refinance the loan. These loans are good for those who plan to sell their homes in 5, 7 or 10 years or plan to refinance at these times.
Buydowns: The interest rate and monthly payment remain the same for a specific period, then the rate and payment increase one, two or three times, depending on whether the loan is a 1/1, 2/1 or 3/1 type. After all of the permitted increases have occurred, the loan stays fixed at the new rate for the life of the loan. In order to "buy the rate down" to a lower interest rate, one is typically charged a fee. The basic advantages of a buydown loan is that it offers a lower rate and monthly payment for the first few years of the loan. These loans are ideal for those who cannot qualify for a fixed rate loan or a lower monthly payment.
Conforming and Jumbo Loans: Conforming loans refer to loan amounts that conform to government service standards as determined by Fannie Mae and Freddie Mac (the original government agencies, set up in the early 1940s, established to help people finance new homes). Conforming loans range in amount from $1 to $227,150. Although not all conforming loans are serviced by these government agencies, the mortgage industry has adopted the term to express loan amounts in this range. A jumbo (non-conforming) loan refers to those loan amounts outside of the "conforming" range or, above $227,150.
Government Loans: Government loans are guaranteed by the federal government. There are three government agencies that offer loans:
Federal Housing Administration (FHA): Offer loans to homebuyers and requires only 3 to 5 percent as down payment. The maximum amount of the loan is based on the average cost of living in a specific region and you do not have to have perfect credit to qualify. The FHA will cover up to 97.75% of the purchase price. To qualify, your debt-to-income ratio cannot exceed 41% and the homes selling in your city or town should not sell for more than $180,000. See FHA Loans. U.S. Department of Veterans Affairs (VA): Offers loans to qualified military veterans, who can borrow up to $203,000 with no down payment required. Closing costs might be paid by the seller. VA loans can be used to make home improvements and refinance an existing loan as well as to purchase a home. See VA Loans.
Rural Housing Services (RHS): Offers low interest rate loans to people with low or moderate income and who live in small towns or rural areas.
Affordable Housing Loans: These loans are for those with low to moderate incomes. Usually to qualify, your total household income cannot be more than the median income in the area where you live. The down payments, closing costs, and income requirements are lowered to help those who otherwise would not be able to purchase a home.
Fannie Mae's Community Home Buyer's Program: Provides loans to those with good credit, but who do not meet other criteria to qualify for a traditional mortgage loan.
3/2 Option: A 5 percent down payment is usually required to purchase a home; however, this option allows borrowers to put down only a 3 percent down payment, while a relative, government agency or nonprofit organization puts down the other 2 percent
Fannie 97: Provides loans to those with enough income to pay a monthly mortgage payment, but not enough money to make the initial down payment. Borrowers can put down only 3 percent as down payment; and closing costs can be provided by a relative, government agency or non profit organization. Loan must be for either a 25 or 30 year term.