When you are hunting for a mortgage, you will find that there
are many different types of mortgages available. I will list
some of the more common ones and their uses.
15 vs 30 Years
Your mortgage term can be just about anything you choose. 15 and
30 year terms are popular these days, although 10 and 20 years
also are available.
The shorter the term, the lower the interest rate. But the main
attraction of shorter term mortgages is the money you save.
For example on a $200,000 mortgage with a fixed 4.5% rate, you
would pay $1013.38 a month for 30 years and $1529.99 a month for
15 years. Over 30 years you would pay $364,816.80 versus
$275,398.20 over 15 years, a savings of $89,418.60 or 24.5% in
interest.
If you cut a very conservative quarter of a percent off for
reducing the lender's exposure by 15 years, your savings will be
nearly 26%.
Adjustable Rate Mortgages (ARM )
ARM’s are mortgages whose rates adjust according to the terms of
the contract you made with the lender.
Usually interest rates are fixed for the first 1, 3, 5, 7 or 10
years. After that period is up, rates will be allowed to
fluctuate within the limits of your contract with the lender.
Terms are usually 15 or 30 years (although you can negotiate
just about any duration you want). There can be a balloon
involved.
Because the lender is not taking as big a risk on losing money
if interest rates rise, these loans will have a lower initial
rate than a fixed mortgage. The lowest rates will be for 1 year
ARM’s and will go up accordingly.
Many people will take out an ARM even in period of low rates,
such as now, because they get even lower rates and are able to
afford more house. However, the borrower is taking the risk that
he can still afford the house after the rates are free to rise.
It used to be common for the contract to limit fluctuations to
2% a year. However, 5% swings are becoming more the norm.
Depending on what happens to interest rates, you might find
yourself priced out of your house. Of course, you could
renegotiate if rates start to go back up.
The average homeowner owns his or her house for approximately 7
years. If you plan to move before the initial fixed term of the
ARM is up, it’s a good choice. If you plan to stay longer than
ten years, a fixed rate might be a better option.
Balloon Mortgage
A balloon mortgage is one that is not completely paid off at the
end of its term.
For example, you might obtain a 15 year fixed rate mortgage that
allows you to pay less than the normal amortization schedule
would call for. At the end of the 15 years, you will still owe a
portion of the principal. How much depends on the terms of the
contract.
An interest only mortgage is an example of this type of
loan. In the case of an interest only loan, the balloon will be
the full amount you originally borrowed.
This type of mortgage allows borrowers either to afford more
house then they otherwise could buy or its reduces their monthly
costs, allowing them to spend or invest their savings elsewhere.
Again, if you are planning to move before the balloon is due and
your proceeds from the sale are enough to cover the balloon,
this might be a good idea. However, you face the very real
possibility of having to come up with cash when you sell to
cover the balloon, especially if you have to sell at a time of
declining housing prices.
BiWeekly Mortgages
A biweekly mortgage is one where pay half of the normal mortgage
payments every two weeks. Since you are making 26 payments a
year, rather than 24, you wind up paying off the interest sooner
and saving considerable interest.
Take the example of a $200,000, 4.5% fixed rate mortgage with a
30 year term. The normal payment would be $1013.37 a month.
The biweekly amount is $506.91. But the payoff is huge. Your
loan will be paid 5 1/2 years earlier and you will save 28% or
$32,639.75 interest.
You can set up your own biweekly mortgage plan with your
existing mortgage, assuming there is no prepayment penalty
(which usually only applies the first few years anyhow). Simply
send in or have your bank debit your checking account for one
half your mortgage payments every two weeks. There should be no
extra costs or fees to do this.
Or you can reach a similiar result by dividing your monthly
payment by twelve and adding that to your payment. In this
example that would come out to be an extra $84.44 a month.
The secret is that any prepayment, no matter how small will
result in saving in interest and a shorter payment period.
Bridge Loans
Bridge loans are used in real estate transactions to cover the
down payment on a new home, when the borrower has equity in his
old home, but not enough cash.
It is generally a short term, interest only loan that is repaid
when the homeowner sells his old house.
Conventional Mortgage
Most mortgages are conventional, the terms just vary. A
conventional mortgage to most people is a 15 or 30 year fixed
rate mortgage with at least 20% down.
Construction Mortgages
These are really loans that carry a higher interest rate than a
normal mortgage. They allow you to borrow the money to build a
house and are converted into a mortgage once the house is
finished.
FHA (Federal Housing Administration)
The FHA is a branch of the Housing and Urban Development
(HUD) Department. It is a depression era creation, meant to
make it possible for people to buy homes at a time when banks
where not granting mortgages.
The FHA insures loans up to certain set amounts, which vary with
the region of the country and the type of loan. Right now the
guarantees run from about $160,000 for a one family house to
somewhat over $300,000 for a four family home.
This type of mortgage is designed to help low and moderate
income people become home owners. It requires low down payments
and has flexible lending requirements.
If the borrower defaults, the government steps in and pays the
guarantee. This makes it easier for lenders to write mortgages
they would otherwise refuse.
Fixed Rate
Fixed rate mortgages have interest rates set for the term of the
mortgage, which can be anywhere between 5 to 30 years.
Although they can be interest only or have a balloon, they
usually are conventionally amortized mortgages.
At times like now, when rates are low, most homeowners want to
lock in the low fixed rates. They are popular when rates are
falling, not so popular when they’re high or going up.
This type mortgage is a very good idea if you're planning to
live in your house for a while.
Home Equity Line of Credit
A revolving credit line secured by your home. Because it is a
mortgage, it carries a lower rate than other forms of credit and
is tax deductible.
It differs from a second mortgage in that it is not for a fixed
term or amount and can be kept in effect as long as you own your
home.
This is used most frequently for debt consolidation and can be
useful if you rip up your credit cards and use the money you
save on interest to invest.
Interest Only Mortgages
This is just what it says. You only pay interest, the principal
is never reduced.
This is the grand daddy of all balloon mortgages and you taking
a big risk that your house depreciates in value rather than the
other way around.
You could very well have to come up with extra cash at closing.
The payments are much lower than on a normally amortized
mortgage and if you have the discipline, it can be a useful
financial planning tool.
Jumbo Mortgages
Mortgage loans over $322,700 (the limit is periodically raised).
Otherwise, the mortgage can be fixed or variable, balloon, etc.
Rates are usually a little higher than for smaller loans.
No Doc or Low Doc Mortgages
This refers to the mortgage application, not to the mortgage
itself. Business owners, people living off investments, salesmen
and others whose income is variable might use low or limited
documentation mortgages.
Very wealthy borrowers or those who want substantial financial
privacy will sometimes use the no doc option.
In either case, in spite of their names some documentation is
required. The lender will accept nothing less than excellent
credit and even then you will pay more for the privilege.
No Money Down Mortgages
These come in two flavors: FHA type loans that allow low or
moderate income borrowers to buy a house with little or nothing
down and the 80-20 plans, where wealthier borrowers with little
money saved up finance 100% of the purchase price.
Under the 80-20 plan a first and second mortgage are issued
simultaneously. The borrower avoids having to buy mortgage
insurance. The two loans are designed to cost less than an 80%
loan plus the insurance, otherwise they make no sense.
If the borrower puts some money down, you will see the mortgage
referred to as 80-10-10 (the last digits will be the percent of
down payment) or some similar number.
It is mostly used by borrowers who haven’t saved enough for a
down payment or by those who have the money, but would rather
use it for other purposes.
Refinancing
This technically means getting a new mortgage at different,
hopefully better terms. A lot of people use it interchangeably
with obtaining a second mortgage or line of credit; in other
words tapping into the equity of their house.
Second Mortgages
Secondary financing obtained by a borrower. They can be fixed in
amount or take the form of a Home Equity Line of Credit,
which is simply a revolving credit line secured by a house.
Homeowners use these forms of financing to consolidate bills, do
home renovations, put their kids through college, etc. They are
tapping into the equity they have in their house to use for
other things.
This is not necessarily a great idea. You must take firm control
of your finances when you start doing this or you risk either
losing your house or having to raise cash to pay the mortgages
off when you sell.
If done properly, you can pay off your debt at a lower, tax
deductible rate and invest your savings.
VA (Veteran’s Administration) Mortgages
The VA provides mortgage guarantees to active duty and
ex-servicemen who meet certain eligibility requirements. (To
read the requirements click here.)
Like with FHA loans, the government guarantee makes it easier
for low and moderate income veterans and active duty service
personnel to obtain mortgages.
The current VA guarantee is $89,912. It is raised periodically.
125% Mortgages
If you want to bet house prices will rise, some lenders will
lend you up to 125% of the value of your house. If you’re right,
you’re okay. Otherwise be prepared to have your checkbook
available when you sell your house.
I’m sure that there are other financing options available that I
haven’t covered and don’t even know about. But most of the main
financing types are covered here.
About the author:
Chris Cooper is a retired attorney who is very familiar with
debt, being in it too many times in his life. These articles
pass on some of the knowledge he has gained striving to become
debt free. He is editor-in-chief of
http://www.credit-yourself.com a website devoted to debt
management
