Types of Mortgage Loans
All mortgage plans can be divided into categories in two different ways: Firstly, conventional and government loans; Secondly, all the various mortgage programs may be classified as fixed rate loans, adjustable rate loans and their combinations.
Conventional and Government Loans
Any mortgage loan other than an FHA, VA or an RHS loan is conventional one; here we are going to focus on the conventional loan program:
Conventional loans may be conforming and non-conforming.
Conforming loans have terms and conditions that follow the guidelines set forth by Fannie Mae and Freddie Mac. These two stockholder-owned corporations purchase mortgage loans complying with the guidelines from mortgage lending institutions, packages the mortgages into securities and sell the securities to investors. By doing so, Fannie Mae and Freddie Mac, like Ginnie Mae, provide a continuous flow of affordable funds for home financing that result in the availability of mortgage credit for Americans.
Fannie Mae and Freddie Mac guidelines establish the maximum loan amount, borrower credit and income requirements, down payment, and suitable properties. Fannie Mae and Freddie Mac announce new loan limits every year.
The 2011 conforming loan limits:
Anything over 4-units is considered a commercial property and cannot be originated through Fannie Mae or Freddie Mac.
Loans above the maximum loan amount established by Fannie Mae and Freddie Mac are known as “jumbo” loans. Because jumbo loans are bought and sold on a much smaller scale, they often have a little higher interest rate than conforming, but the spread between the two varies with the economy.
Loans that do not meet the borrower credit requirements of Fannie Mae and Freddie Mac are called “B”, “C” and “D” paper loans vs. “A” paper conforming loans. B/C loans are offered to borrowers that may have recently filed for bankruptcy, foreclosure, or have had late payments on their credit reports. Their purpose is to offer temporary financing to these applicants until they can qualify for conforming "A" financing. The interest rates and programs vary, based upon many factors of the borrower's financial situation and credit history.
With fixed rate mortgage (FRM) loan the interest rate and your mortgage monthly payments remain fixed for the period of the loan. Fixed-rate mortgages are available for 40, 30, 25, 20, 15 years and 10 years. Generally, the shorter the term of a loan, the lower the interest rate you could get.
The most popular mortgage terms are 30 and 15 years. With the traditional 30-year fixed rate mortgage your monthly payments are lower than they would be on a shorter term loan. But if you can afford higher monthly payments a 15-year fixed-rate mortgage allows you to repay your loan twice as faster and save more than half the total interest costs of a 30-year loan, as illustrated on our graph:
The payments on fixed rate fully amortizing loans are calculated so that at the end of the term the mortgage loan is paid in full. During the early amortization period, a large percentage of the monthly payment is used for paying the interest. As the loan is paid down, more of the monthly payment is applied to principal, as illustrated on our graph:
With bi-weekly mortgage plan you pay half of the monthly mortgage payment every 2 weeks. It allows you to repay a loan much faster. For example, a 30 year loan can be paid off within 18 to 19 years.
Balloon loans are short-term fixed rate loans that have fixed monthly payments based usually upon a 30-year fully amortizing schedule and a lump sum payment at the end of its term. Usually they have terms of 3, 5, and 7 years.
The advantage of this type of loan is that the interest rate on balloon loans is generally lower than 30- and 15- year mortgages resulting in lower monthly payments. The disadvantage is that at the end of the term you will have to come up with a lump sum to pay off your lender, either through a refinance or from your own savings.
Balloon loans with refinancing option allow borrowers to convert the mortgage at the end of the balloon period to a fixed rate loan—based upon the outstanding principal balance—if certain conditions are met. If you refinance the loan at maturity you need not be re-qualified, nor the property re-approved. The interest rate on the new loan is a current rate at the time of conversion. There might be a minimal processing fee to obtain the new loan. The most popular terms are 5/25 Balloon, and 7/23 Balloon.
Variable or adjustable loan is loan which interest rate, and accordingly monthly payments, fluctuate over the period of the loan. With this type of mortgage, periodic adjustments based on changes in a defined index are made to the interest rate. The index for your particular loan is established at the time of application.
Well known ARM indexes include:
- Constant Maturity Treasury (CMT)
- Treasury Bill (T-Bill)
- 12-Month Treasury Average (MTA or MAT)
- Certificate of Deposit Index (CODI)
- 11th District Cost of Funds Index (COFI)
- Cost of Savings Index (COSI)
- London Inter Bank Offering Rates (LIBOR)
- Certificates of Deposit (CD) Indexes
- Bank Prime Loan (Prime Rate)
- Fannie Mae's Required Net Yield (RNY)
- National Average Contract Mortgage Rate
New interest rate = index + margin
The margin is fixed percentage points added to the index to compute the interest rate. The result will then be rounded to the nearest one-eighth of a percent.
The margins remain fixed for the term of the loan and are not impacted by the financial markets and movement of interest rates. Lenders use a variety of margins depending upon the loan program and adjustment periods.
Most ARMs have an interest rate caps to protect you from enormous increases in monthly payments. A lifetime cap limits the interest rate increase over the life of the loan. A periodic or adjustment cap limits how much your interest rate can rise at one time.
Your mortgage disclosure will tell you the exact index to be used, whether the weekly or monthly value applies, the lead time for your index, the margin, and any caps.
With fixed-period ARMs homeowners can enjoy from three to ten years of fixed payments before the initial interest rate change. At the end of the fixed period, the interest rate will adjust annually. Fixed-period ARMs—30/3/1, 30/5/1, 30/7/1 and 30/10/1—are generally tied to the one-year Treasury securities index. ARMs with an initial fixed period beside of lifetime and adjustment caps usually have also first adjustment cap. It limits the interest rate you will pay the first time your rate is adjusted. First adjustment caps vary with type of loan program.
The advantage of these loans is that the interest rate is lower than for a 30-year fixed (the lender is not locked in for as long so their risk is lower and they can charge less) but you still get the advantage of a fixed rate for a period of time.