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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.
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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. |
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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. |
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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. |
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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?"
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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.
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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
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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.. |
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
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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
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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.
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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.
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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!
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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.
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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!
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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