Mortgage Types and Terms
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.
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.
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.
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.
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.
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.
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.
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.
Other Mortgage Types and Options
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.
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.
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.
