Mortgage Types - Discussion (updated 7/28/2009)

As a result of  the current mortgage and housing market debacle, the mortgage market is in a state of flux.  With the recently passed legislation, new regulations become effective October 1, 2009.  A few are noted below.

It is now more important than ever to shop several mortgage bankers and brokers for the best terms available to you given your own situation.  Check out not only the interest rates but also other upfront costs like origination fees, discount points, mortgage insurance, and some less obvious fees like application fees, credit checks, documentation fees and various other costs.  Have a good understanding of all the costs associated with financing your purchase as early as possible in the process.

In order to amke a "strong offer" on a home, the buyer should have a written "pre-approval" from the selected mortgage banker or broker to submit with the offer to purchase.

There are hundreds of loan programs available with various down payment, income, professions, credit scores and other qualification requirements. Many individualized loan programs are a combination of these types and a home equity line of credit. This list covers the major types and is for general information only. Review your personal situation with your Realtor, financial advisor, mortgage banker or broker to help you determine what is the best for your individual situation and risk tolerance.

If you have any questions, want detail info on typical costs for mortgages or would like references for local lenders and brokers, e-mail me billfreeman@frgnc.com or call 919-338-0788.

See BankRateCom sidebar on right side of page for a snapshot of current rates.  Explore their website for more information.  I can discuss implications of the rate structures with you.

• Loan Limits
• Fixed Rate Loans  
• Adjustable-Rate mortgages (ARMs)   
• Government Insured Loans
• Special Loan Programs   - Interest Only and Subprime

 

 

 

 

Fixed Rate Loans

A fixed-rate mortgage provides an interest rate that will remain the same over the life of the loan. The typical term of a fixed-rate mortgage is usually 15 or 30 years, but other terms are available (10, 20, 40, 50). The main advantage is that if interest rates increase, your interest rate will remain the same.

 

30 Year Term

• Lowest monthly payment (P&I) of standard fixed rate loans
• Enable buyer to afford "more house" by extending payments over a long term
• Most of payment is tax deductible interest during the early years of the loan
• For most buyers - with inflation and housing apppreciation, payments seem very low towards end of loan

15 Year Term

• Lower interest rate, but a higher monthly payment (P&I) than 30 year loan
• Total interest paid over term of loan is much lower
• Builds equity much faster creating "savings"

 

ARMs (Adjustable Rate Mortgages) 

The adjustable rate mortgage (or "ARM") is a loan program that initially has a fixed interest rate for a predetermined period. Once the fixed rate period is up, the loan is subject to a changing interest rate which is adjusted from time to time to keep it in line with changing market rates at predetermined dates. This means when interest rates go up, your monthly home loan payments may go up. And, when interest rates go down, your monthly home loan payments may go down.

ARMs are attractive because they offer start rates that are lower than the interest rates of fixed rate home loans. This typically enables you to begin with lower monthly payments and qualify for a larger loan.

How ARMS work

Most ARMs are amortized over a 30 year term at the start of the loan.

A start rate, also known as the initial interest rate, gives you a low monthly payment for a set amount of time (such as 1 year). After the start rate period is over, your interest rate is based on the performance of a financial index, such as the average interest rate, LIBOR or yield on Treasury bills.

Some ARMs (Option ARMS) may have a low "teaser" initial interest rate that may step up to the market rate over a defined period. During this period the principle amount of the loan increases to offset the difference between the market and teaser rates. In effect the home buyer is borrowing part of the monthly payment and repaying it later.

How often your payments are adjusted based on the index, and how much rates and payments increase at each adjustment, depends on your loan terms. A 6-month ARM adjusts every 6 months. A 1-year ARM adjusts once a year.

At each adjustment, the new rate is computed by adding the margin — a predetermined amount that remains the same for the life of your loan — to your financial index. Example: If the interest rate for the financial index was 5.5% and your margin 2%, then your rate at the time of adjustment would be 7.5%.

Two "caps" may put a limit on the maximum amount your rate can increase. The periodic cap sets the maximum your rate can go up from one adjustment period to the next. The life cap sets the maximum interest rate for the life of the loan.

Some ARMs offer a conversion feature that allows you to convert to a fixed rate loan at certain times during your loan.

Fixed Period ARMs

If your risk tolerance or mindset doesn’t like the payment changing in 6 months or a year, or know exactly when you'll be ready to move to a new home, you might want to look into an ARM that protects you against the possibility of many changes for a set number of years.

A fixed period ARM starts with a lower rate than standard fixed rate loans. Your rate then stays the same for the first 3, 5, or 7 years, depending on the fixed period ARM you choose. At the end of that period, your interest rate adjusts every year like a regular ARM according to a financial index (that's why some lenders call them 3/1, 5/1, and 7/1 ARMs)

Home buyers with a higher risk tolerance and / or special situations are candidates for ARMs, for example those who

• Plan to sell their home within a short period of time - usually before the fixed rate period is up
• Believe their income will increase and want lower payments for an initial period or to qualify for a larger mortgage
• Believe they can refinance at a lower rate within their risk tolerant time frame
• Believe that long term rates will not increase for long periods of time and wnat the lowest possible rate

 

Government Insured Loans

 The Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA) offer government-insured loans. These loans have features that make it easier for first-time home buyers to obtain. Features include low down payments and flexible lending guidelines. The government does not make the loan, but insures a certain amount to minimize the risk for the lending institution.

FHA Loans 

• Low down payment - typically 3% of the lower of the FHA Appraised Value or the purchase price
• FHA Insurance replaces Private Mortgage Insurance
• Fixed Rate and ARMs are available
• County by County maximum loan amounts
• No maximimum limit on income or earnings

VA (Veterans Administration) Loans

• No down payment (100% financing)
• Loan limit is same thoughout USA
• Easier to qualify than a conventional loan
• No PMI or FHA or other payments for loan insurance
• Fixed rate and ARMs

 

Special Loan Programs 

These loan program can be complex and have many guidelines that can affect the benefits. As with all loan programs, the borrower should ensure they have a complete understanding of the loan parameters and risks before committing to purchase a home based on incomplete information, especially what is the true APR, how much a mortgage payment may increase and what, if any, are the prepayment penalties.

Interest Only Loans

Interest only loans allow for a lower payment than the traditional amortized mortgages. An interest only payment does not repay any of the principal but only the interest due on the loan balance. The option to only pay interest portion usually lasts for a predetermined period, typically 5 or 10 years. Depending on the terms of the loan, borrowers may the right to make an interest only payment or add more money to repay part of the loan balance.

Sub-Prime Loans

When home buyers cannot qualify for prime financing, sub prime programs may be available. Due to the higher risks of these loans, higher interest rates and pre-payment penalties are common.

Subprime loans used to be hot. Now they're not. Subprime lending barely exists because so many of the loans went bad. According to National Mortgage News, the top 10 subprime lenders in the first quarter of 2007 underwrote $52.3 billion; the top 10 subprime lenders in the first quarter of 2008 underwrote $3.3 billion.

From 2003 until last year, stated-income loans were the big fad because they allowed borrowers to exaggerate their incomes without having to provide tax documents that might prove otherwise. Now stated-income loans are rare because they're deemed too risky. They were called "liar's loans" for a reason.

Now, more than a year after stated-income and subprime loans fell out of favor, the Federal Reserve has banned stated-income subprime loans.

Lenders will have plenty of time to adapt to the new rules. They don't go into effect until Oct. 1, 2009.

 

Loan limits extended permanently

There are maximum amounts for loans that the FHA will insure, and that Fannie Mae and Freddie Mac will guarantee. Those limits were raised temporarily this year. The new law raises limits permanently.

For FHA-insured mortgages, the new limit will be 115 percent of the median home price in that area, up to $625,500. That provision will affect loan limits in higher-cost areas. In lower-cost areas, the current FHA limits won't decrease.

For conforming mortgages -- those eligible to be bought by Fannie Mae and Freddie Mac -- the conforming limit will remain at least $417,000 for a single-family home. It can be higher than that. Starting next year, the new limit is either $417,000 or 115 percent of the area's median home price, whichever is higher -- up to $625,500. After that, the limits go up or down according to a price index.