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Mortgage Types and Terms
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Choosing the right mortgage may seem confusing because there are so many different options and
variables within each option. This article intends to clarify what the differences are between
mortgage types and the terms related to each one.
Fixed-Rate Mortgage
Adjustable-Rate Mortgage (ARM)
Convertible ARM
Delayed ARM
Balloon Mortgage
VA and FHA Loans
Shared-Appreciation Mortgage (SAM)
Other Types
Bi-Weekly Payment Schedule
No-Documentation or Low Documentation Mortgage
Reverse Mortgage or Lifetime Mortgage
Fixed-Rate Mortgage
This is the most common/popular mortgage. As its name implies, it offers a fixed interest rate and
monthly payment that remains in effect throughout the term of the loan. Most of the time, fixed-rate
mortgages are offered in 15 and 30-year terms; however, there are many lenders that also offer 20 and
40 year options. It's an appealing mortgage to many buyers because if offers a certain degree of
consistency in their monthly budget. The biggest drawback to a fixed-rate-mortgage can also be
viewed as its greatest benefit: when mortgage rates go up your rate stays the same and when rates
drop it stays the same so refinancing would be required to take advantage of any significant dips
in rates. Top
Adjustable-Rate Mortgage (ARM)
For those people willing to accept a certain degree of risk, or those who intend to move within
3 or 4 years, an adjustable rate mortgage may make sense. As it's name implies the interest rates
are not static - they may go up and may go down periodically. ARMs typically fall into two
categories: one-year and scheduled. The interest rate is adjusted annually for a one-year ARM. The
interest rate for a scheduled ARM is adjusted according to the agreement between the buyer and
lender. For example, a 5/1 ARM gives the buyer a fixed rate for 5 years and annually adjustable
rates thereafter. It's important to get specifics from the lender - ask how the "caps" on your
ARM work. "Caps" limit the amount a lender can increase the interest rate in a single year and over
the lifetime of the loan. Top
Convertible ARM
The convertible ARM is and adjustable rate mortgage (ARM) that can be converted to a fixed-rate
mortgage during a specific period of time (e.g. a one-year ARM with the option to convert after
the first period and before the fifth adjustment period). The interest rate for a convertible ARM
is typically higher than a standard ARM, and a fee is usually charged in order to convert.
Furthermore, the fixed interest rate is often slightly higher than the overall market rate. Each
lender uses their own formulas to calculate the fixed rate so get the specific terms from the
lender before signing. Top
Delayed ARM
A delayed ARM has a fixed interest at first but is followed by a fluctuating rate. The interest
rate is usually adjusted annually for the life of the loan. For example, with a 5/1 ARM the interest
stays the same for the first five years but is then adjusted on the sixth year and each year
thereafter. The delayed ARM offers a lower interest rate (compared to fixed-rate) so buyers that
choose this type of loan usually plan to sell their homes before the interest rate is subject to
adjustment. Top
Balloon Mortgage
Balloon mortgages require the buyer to pay off the loan in full or refinance the loan at the end
of the mortgage term. The term and qualifications vary by lender but usually span 5 to 7 years and
require at least 20% down payment. The greatest advantage of a balloon mortgage is that the interest
rate is usually 3/8 - 3/4 of a point lower than a fixed-rate mortgage offering lower monthly payments.
The greatest drawback of a balloon mortgage is that the buyer will be unable to make the balloon payment
or secure financing at the end of the term. If this happens, the buyer could lose the home and all
money paid to the lender up to that point. Buyers that use balloon mortgages are usually first-time
homebuyers that expect to buy a new home to scale with the size of their growing family and buyers
that anticipate relocating with their employer within the term of the mortgage.
Top
VA and FHA Loans
Government-sponsored mortgage loans. Veterans may qualify for Veterans Administration mortgages.
There are caps on the amount of a VA loan that a buyer can get, but this mortgage type could be
ideal for buying a lower priced home with a small down payment.
Federal Housing Administration loans are available to Americans with lower incomes that are buying
modestly priced homes. Top
Shared-Appreciation Mortgage (SAM)
A SAM is a mortgage loan in which the lender offers a lower interest rate in exchange for a
percentage of the homes appreciation (if any) when the property is eventually sold. The amount
and term of the loan vary but generally, the longer the term the higher the percentage of profit
the lender will assume. For example, the buyer purchases a $200,000 home using a SAM with a
five-year term and a 50% split. The home is sold five years later of $300,000 - an increase
of $100,000 so the lender is owed $50,000. It's important to note that the appreciation is based
on market value, not the actual sale price of the home. So, using the example above, if the home
was valued at $300,000 but was sold for $250,000, the lender is still owed $50,000 not
$25,000. Top
Other Mortgage Types and Options
Bi-Weekly Payment Schedule
By paying bi-weekly rather than monthly, buyers save interest and build equity much more quickly.
Basically, by making 13 monthly payments (52 weeks = 26 bi-weekly payments) instead of the usual 12,
the mortgage would be paid off in about 22 years as opposed to 30 years with standard payments. This
equates to a huge savings in interest payments.
Top
No-Documentation or Low Documentation Mortgage
These mortgage types typically require higher down payments (25% or more) and come with higher
interest rates, but the lender does not perform income verification. Buyers using this type of
mortgage generally want to expedite the process or do not have a consistent income stream as may
be the case if the buyer is self-employed.
Top
Reverse Mortgage or Lifetime Mortgage
This type of mortgage appeals to retired borrowers that own their home and want to cash in on its
equity. The lender sends the homeowner a payment each month and the homeowner lives in the home for
the remainder of his or her life. While in the home, the borrower is still responsible for paying
property taxes, homeowners insurance, and making property repairs. Upon the homeowner's death, the
estate repays the loan with interest. Reputable lenders do not want the house so, typically, the
home is sold to pay off the loan.
Top
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| Copyright 2005. Nancy Clark. All Rights Reserved. |
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