Types of Mortgages available for Residential Purchases

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Your Mortgage Choices:
Types of Mortgages available for Residential Purchases
(Houses or Condominiums)


Until 30 or so years ago, there were only a few types of mortgages available to the residential home buyer. Meanwhile, the mortgage market has changed a lot, as the number of house owners has increased and, mortgages have become more interesting as an investment to individuals and a large number of financial institutions. This meant, that the number of financial products available to the normal home buyer, has increased dramatically


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Long before the advent of "sub-prime" mortgages, meaning "high risk group" based equity lending, a house purchaser was limited to fixed interest rate mortgages with amortization rates of between 10 and 30 years.

Today the borrower, subject to his credit rating, is offered a wide array of financial products. Here is a list of the most common ones which the average residential borrower will come across.


The Most Common Types of Mortgages for Residential Property Purchases


Fixed Rate Mortgages This used to be the standard mortgage one could obtain from all main street banks and Savings and Loans. It still is one of the most common mortgages. It is a fully amortized mortgage with maturities of 10, 15, 20, 30 and nowadays even 40 and 50 year maturities.The mortgage is paid in monthly installments, until at the end of the maturity period the mortgage is fully repaid. As is implied in the name, the interest rate (APR) is fixed for the whole period until maturity.
FHA Loans This loan type is insured through a mortgage insurance that is paid as part of the monthly repayments of the mortgage. It is a government operated home finance system and requires only minimal up-front down payment on a property. Additionally, the Credit Scores (FICO Scores), are not part of the evaluation process in who gets a loan.
VA Loans These mortgage loans are guaranteed by the Department of Veterans Affairs and are given to active, honorably and dishonorably discharged former soldiers. Under certain circumstances, they are also given to the surviving spouses of deceased veterans. The amounts and conditions under which these loans are given depend on the years of service completed in the military, and other conditions. The lender is usually a normal commercial bank with the DVA providing the guarantee. This type of mortgage does not require any down payment.
Adjustable Rate Mortgages An adjustable-rate mortgages (ARMs) is another fairly common choice of mortgage. The interest rate can move up or down, depending on the market conditions and the prevailing interest rates. The important issues to look out for are
  • how soon after a the reference interest rate changed in the market (based on LIBOR, Treasury Prime Rate or another reference rate, usually as published in the Wall Street Journal), will the interest rate of the mortgage be adjusted; and
  • how often, per year, can the interest rate be changed (up or down); and
  • does the mortgage contract have a maximum rate (rate cap) per year which limits the maximum annual adjustment;

Another important question to ask is:"What events, other than changes in the reference interest rate, could trigger a change in the mortgage interest rate?"

Interest-Payment-Only- Mortgages Although, this is not so common as a primary mortgage, it is sometimes used as a sort of "top-off mortgage". The monthly payment only covers interest payments, and the principal becomes due at the end of the maturity as a "balloon payment". Most commonly, maturities for this type of mortgage are short: one, two or up to five years.

More recently, interest only mortgages have been offered to "sub-prime clients" who could not afford the monthly interest and amortization payments for the initial, or even an extended period. Sometimes this "interest only repayment" is offered as a temporary option during Loan Modification negotiations, in order to avoid default and foreclosure.

Beware!

A dangerous variation of this are options that have been offered as loan modifications, whereby the lender is not able to pay the full amount of interest and the unpaid interest is being added to the principal. Thus, resulting in a negative amortization of the mortgage.

With all the above fixed interest rate mortgage types there is an option that some people want to exercise. It is known as a Mortgage Buydown:

Some Additional Option for Fixed Interest Rate Mortgages

Mortgage Buydowns "Buying Points" is an often exercised option on fixed interest mortgages, to buy down your rate of interest by a quarter, half or even a point (percentage point). If you are intending to keep the house for an extended time period, and, if you have the cash, this is worth it. Though you have to ask yourself, whether using that money to make a larger down payment is not a better idea..

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In most cases prospective residential property owners select one of the above mortgage options. However, there are other possibilities to finance a house purchase. Interestingly enough, some of these complicated financial instruments were offered to the least sophisticated lenders during the sub-prime boom.

Unless you really know and fully understand what financial risks you are exposing yourself to, we would recommend that you stick to one of the more conventional mortgages shown above.


Exotic and Hybrid Mortgages


Combo and Piggyback Mortgage Loans Sometimes it ids an advantage to have two mortgages on the house. The first or principal mortgage for 80% of the purchase price of the property, fixed rate and, say of 30 year maturity. The second one for, say 10% of the purchase price, variable interest and running five years to maturity. Leaving only 10% for a down payment. It is one way to avoid having to pay private mortgage insurance, because your down payment is less than 20%. This is know as a Combo Mortgage. Note, that both mortgages have the same seniority. The mortgages can also be arranged in any combination of interest rates and maturity periods.
Option ARM Mortgage Types This type of mortgage has been one of the main culprits in the sub-prime crisis. Mainly because it was given to people who did not understand the implications of their contract.

The reference rate of interest is usually calculated, usually monthly, on the basis of

  • LIBOR,
  • Cost of Savings Index,
  • the average monthly Treasury Bill interest rates, or
  • the COFI, which is the acronym for the 11th District Monthly Weighted Average Cost of Funds Index (that abstruse selection of a reference interest rate alone should make the financially unsophisticated borrower wary!),
  • PLUS
  • the Margin Rate of the Bank.

Together, they form the Fully Indexed Rate of Interest.

The Option Adjustable Rate Mortgage allows the lender to repay monthly, either

  • Minimum Payment is usually payment of the equivalent of the reference rate of interest.The bank margin interest is added to the principal, which will result in negative amortization. The amount of the loan you owe to the borrower will therefore grow, every month you pay the minimum only. Usually there is a time limit, one, two or five years, to being able to pay minimum payments only.
  • Interest Payment only. You pay the reference interest rate plus the bank margin interest, but no principal repayments, or
  • The Fully Indexed Option Payment, which is made up of the reference rate plus the bank margin rate, plus the amortization of principal (depending on the terms - 10, 20 or 30 years - of the maturity of your mortgage)

It is sometimes argued that this type of mortgage is a good option for people with highly fluctuating income streams! However, it could also be argued, with significantly more justification, that the last thing you would want is a mortgage with an unpredictable level of interest payments and principal that becomes larger!


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Special Mortgages


Streamlined-K Mortgage Loans from FHA In order to enable people to rehabilitate older homes and neighborhoods, the FHA is offering a mortgage that includes up to $35,000 in funds that can be allocated to repairs. It is known as the Streamlined 203K program

Although the total amount for improvements is not as much as for the 203k program, it is easier to obtain and requires a lot less paperwork.

Bridging Loans (Swing Loans) If you have enough equity in your property and you are intending to sell it while purchasing another property, the bank might consider you for a bridging or swing loan for the period until your old house has been sold.

Your existing property is the security for the intermediate financing of the purchase of the new property. But remember, this requires significant equity in your existing property.


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Refinancing Mortgages


There are many reasons for people to refinance a property. Sometimes they have to access their equity, because of other financial pressures or commitments. More often and more recently, it has become a sort of a "cash cow" with which to buy other consumables.

Equity Mortgage Loan Types Revolving equity credit lines have become an accepted means of financing major consumer expenditures.

An equity line of credit is second in position and junior to the existing first mortgage. The loans can be fixed, adjustable, or a permanent line of credit, from which the borrower can draw funds as needed and repay them with, at least, a minimum payment every month. Equity lines of credit are considerably cheaper than credit cards, but they are a secured credit, as opposed to a credit card, which is unsecured! Think twice, before you pay off a credit card with funds from your equity line of credit! You will lose your house if you default on an equity line of credit!

Reverse Mortgages Reverse mortgage have become popular since they are advertised by a well known actor. This mortgage type has also become a mine field for elderly, and not necessarily sophisticated, borrowers with predatory lenders praying on the potential borrowers!

In theory it is quite a simple method of tapping into your equity, when you need it most, that is, when you retired:

  • The lender gives you a mortgage, from which you get a monthly payment or a lump sum or, a combination of the two, in return for a financial interest in the house, which depending on how long you live could become "ownership of the house" upon your dead.
  • The lender charges you a rate of interest, calculated the same way as in any other mortgage, plus fees, which they add to the amount of money you get in the lump sum or the monthly payments.

There are few ground rules for Reverse mortgages:

  • You have to be 62 or older to qualify
  • You have to have sufficient equity in your property
  • existing mortgages have to be paid off so that the property if free and clear (this is usually done as part of getting a reverse mortgage)
  • You have to continue living in the property.
  • Any necessary maintenance on the property will have to be done before you can get a reverse mortgage. The lender will have the property inspected.
  • Your credit history and credit scores are irrelevant for this type of loan.

So where are the pitfalls?

Banks and mortgage companies are in this to make money. And there is nothing wrong with that. Having discovered a new untapped, and, from a consumers point of view, fairly "unsophisticated" market. Consequently, they load the mortgage with a lot of upfront fees!

The industry is poorly regulated, and the fees will vary from lender to lender. Because they often use different terminology for the fee components, it is even for sophisticated borrowers difficult to compare like with like! Some of the normal fees are:

  • You will pay normal closing costs as for any other mortgage. For details of such costs go to our page. Everything from establishing an escrow account for tax and insurance, title search and recording applies!
  • You pay a Loan Application Fee. From that the loan officer gets his sign up bonus. Some banks try to be clever and call that points, referring to the buy down of your interest rate. But it has nothing to do with that!
  • You will have to pay a monthly Mortgage Insurance Premium for an insurance that will pay for a loss to the lender if your home is worth less than the amount owed at the end of your loan. AIG is one of the large insurers for that!
  • You will pay Monthly Lender Fees. Every time the borrower gets a payment or asks for a disbursement, the lender will charge you a fee. These fees may be substantial!

Wells Fargo offers a calculator, which will tell you how much money you can get and what it will cost. You will find the Wells Fargo Reverse Loan Calculator here.

Another possibility is the Home Equity Conversion Mortgage, also known as the "HomeKeeperMortgage" from Fannie Mae. They are insured by the U. S. Department of Housing and Urban Development.

The key to selecting the right lender and from the borrowers point of view, the right cost effective program for a reverse mortgage is to get full information on the lender from HUD or a mortgage counselor who is not an agent or salesmen for any of these programs.

Which mortgage you select depends on your circumstances. One rule you should follow is to keep it simple. If your mortgage adviser offers a loan with conditions that you do not understand or that is simply too complicated to assess the risks, DON'T TAKE IT!

THE CHANCES ARE, THAT THE MORTGAGE ADVISER HIMSELF DOES NOT UNDERSTAND ALL THE RISK IMPLICATIONS FULLY. Always remember, most mortgage advisers are salesmen on commission!


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There are some books from amazon that you might want to consult. If you buy a second hand version, be careful that it is a recent edition which includes any alga;l changes that have been implemented as a consequence of the "sub-prime melt down".

Books about Mortgages from Amazon

One always knows when something has become "the latest trend" by the sheer number of books that are published on the issue. The above books are informative on reversed mortgages. But, you should always be aware that some of the writers are on a "mission" to convert you into a believer! Try to sort that out, when you read through some of these guides.


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