Types of Mortgages - Mortgage Loan
The seller accepted your offer and the mortgage lender approved your
home loan application. So what type of residential mortgage do you
pick given the choices available in the market today? There are quite
a few considerations: What is your future earning potential, how long
do you plan to keep the house and where do you think mortgage interest
rates are going. Finally, how big should your mortgage loan be? The
basic rule is the annual upkeep of your property (mortgage payments,
utilities and insurance) should not exceed 30% of your gross annual
income. Read on to find which home loan is the best mortgage suited
Fixed Rate Mortgage
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This is the most common type of residential home loan. The mortgage
loan is repaid through fixed monthly payments of principal and
interest over a set term. The borrowing rate stays the same over
the life of the residential mortgage loan. The term of the home
mortgage can be 10, 15, 20 or the popular 30 year fixed rate mortgage
term. The way fixed mortgage loans are structured, the mortgage
interest is front loaded. In the first years of the residential
loan, the bulk of the monthly payments go to paying mortgage interest.
It’s only later that you will start significantly building
equity in your home as more of your mortgage payments go towards
paying down the mortgage loan principal. A fixed rate mortgage
is ideal for those who intend to stay in their properties for
a long time.
Apply for a Fixed
Stability: With your mortgage rates fixed, the
loan period set, you know what your mortgage payment will exactly
be for the whole life of the residential loan. Given the certainty
of your mortgage loan payment, you can plan your finances accordingly.
Lower payments in a low mortgage interest rates environment: A
lower monthly mortgage payment frees up your purchasing power
and gives you greater financial flexibility. Using a 30 year fixed
mortgage of $150,000 as an example, if the borrowing rate is 6.50%,
the monthly payment would be $948.10. If the mortgage interest
rate is 8.50%, the mortgage monthly payment would amount to $1,153.37.
The difference in monthly payments is $205.27.
Affordability: If mortgage interest rates are
high, you might have difficulty making the high mortgage payments.
The home loan in this situation might not be approved.
High payments in a high mortgage rate environment: Nobody wants
to be saddled with high home mortgage payments over the long term.
When borrowing rates are lower, you can refinance your mortgage.
A refinance mortgage is the process of replacing your current
mortgage with a new residential mortgage with better borrowing
The Adjustable Rate Mortgage (ARM)
The adjustable rate mortgage is usually referred to as an ARM.
An arm adjustable rate mortgage is a combination of a fixed rate
mortgage and a floating rate mortgage. At the beginning of the
mortgage term, the mortgage rate is fixed for certain periods.
These periods could be for 3, 5, 7 or 10 years. After this period
expires, the mortgage interest rate becomes adjustable.
A popular ARM home loan is the 5 1 ARM Mortgage.
Five denotes that the period and the borrowing rate are initially
fixed for 5 years. After the fifth year, the mortgage rate becomes
Apply for a Adjustable
Conversion Options: Some ARM home loans come
with options to convert them to a fixed rate mortgage based on
a pre-determined formula, during a given time period. Example:
the 1-year treasury bill adjustable may be converted to a fixed
mortgage rate during the first five years on the adjustment date.
Meaning, you have the option to convert during the 13th, 25th,
37th, 49th and 61st months of the mortgage loan.
Components of an ARM Adjustable Rate Mortgage
There are several components that go into calculating the adjustable
rate of an ARM mortgage.
Index: This is the market derived interest rate
which is used as a base to set future rates of the ARM mortgage
loan. Depending on the index chosen, the home borrowing rate could
be adjusted monthly, quarterly, semi-annually or annually. The
index could be pegged to the following: Treasury Bill Rates, The
Prime Rate, Libor and 6 month CD. These indexes are usually published
in the newspaper.
Margin: This is the spread added to the index
to determine the actual rate charged to the mortgage borrower.
Example: Index is based on One Year Treasury Bills 3%. The margin
is 2%. The mortgage rate the borrower pays is 5%. Rate = Index
Rate + Margin
Adjustment Period: This is the duration for which the mortgage
interest rate is fixed. If the adjustment period is one year,
then the interest rate will remain fixed for one year, after which
time it will adjust.
Adjustment Cap: This is the maximum the interest
rate can adjust either up or down for each adjustment period.
Example: The adjustment cap is 1 point. The index based interest
rates since the last adjustment period went up 1.5 points. The
most you will be paying would be 1 point due to the cap.
Lifetime Cap: The maximum mortgage interest rate
charged over the duration of the arm mortgage loan. The cap can
be as high as 6%. The cap is based on the interest rate from the
first year adjustment period. The rate is 5%. The highest the
mortgage interest rate can go is 11% (Base Rate + Lifetime Cap).
Teaser Rate: This is the starting interest rate
of the arm adjustable rate mortgage. It is usually referred to
as the teaser rate, since it is lower than the fully indexed rate.
The initial low mortgage rate is used to attract people. An arm
mortgage is ideal for people who intend to stay in their homes
for no more than 5 to 7 years. The benefits of an arm are realized
at the beginning.
Affordability: If current mortgage rates and housing
prices are high, this may be the only home loan option available
to you. You may have a better chance of getting the home loan
since the lender incorporates the gross monthly income and the
monthly loan payment amount to determine how much you qualify.
The monthly amount will be less with a lower interest rate so
you might qualify for more.
Interest rates have peaked: By going with an adjustable
rate mortgage arm at the peak of the interest rate cycle, the
successive rates will be lower as interest rates go down. Your
monthly home mortgage payments will be lower.
Complicated to understand: Unlike a fixed rate
mortgage that is simple to understand, there are many variables
that go into calculating adjustable rate mortgage loans.
Interest rates have bottomed out: By going with
an adjustable rate mortgage arm at the bottom of the interest
rate cycle, successive borrowing rates will likely go higher as
interest rates go down. Your monthly mortgage payments will become
Uncertainty: If you plan to be at your property
for more than 7 years, you will be dealing with the uncertainty
associated with an ARM mortgage. After each adjustment period,
you will bet getting new mortgage payments.
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Interest Only Mortgage
An interest only home mortgage features no payments of principal
made at the beginning of the home loan. The monthly payments consist
only of mortgage interest only. Due to the lower monthly mortgage
payments, you qualify for a bigger residential loan. An interest
only home mortgage allows you to buy more home while keeping your
monthly mortgage payments low.
Not Interest Only For The Whole Mortgage Loan Term
The interest only payments do not go on for the whole term of
the home loan mortgage. Interest only mortgage payments periods
range from 1 year up to half the term of the mortgage loan. Interest
only loan mortgages are available in adjustable rate mortgage
format and fixed mortgage format.
Bigger Monthly Mortgage Payments
After the interest only payment is over, you will begin making
payments on your mortgage principal. Your monthly mortgage payment
will go up considerably. For example, you took out a 15/30 year
interest only mortgage. After the 15th year, the principal balance
will be amortized over 15 years. With a $175,000 home loan with
a mortgage borrowing rate of 6.50%, the interest only monthly
payment is $947.92. When the principal payments kick in after
the 15th year, the mortgage monthly payment jumps to $1,524.44.
Lower mortgage payments: The lower monthly mortgage
payments let you purchase a home where a fixed mortgage loan would
not. You get to jump on the housing bandwagon
Free up cash to invest the money elsewhere: Instead
of using the cash to pay down your mortgage principal, you can
invest in other vehicles such as stocks and mutual funds to generate
a superior return.
Income Risks: There are no assurances that your
income will rise fast enough to cover the higher monthly mortgage
Property Risks: Instead of the property rising
fast enough to pay off your interest only home mortgage, it could
stay at current levels or even drop. As a result, you might require
another loan just settle the interest only mortgage loans.
No guarantee of getting superior returns in other investments:
If you used the money to generate returns in investments such
as equities and mutual funds, there is no guarantee you’ll
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Mortgage payments are made every two weeks. The amount paid is
half of what your monthly mortgage payment would be. On an annualized
basis, there are two extra payments in a year. You will be making
26 biweekly mortgage payments instead of 24 payments.
Save Thousands On Mortgage Interest And Pay Off Your Mortgage
A bi weekly mortgage program has you paying down your principal
mortgage earlier. As a result, you’ll save significant amounts
in mortgage interest and pay off your home mortgage years earlier.
Example: 30 year fixed mortgage $175,000 Interest Rate: 6.75%
By opting for a bi weekly mortgage payment plan for this mortgage,
you will be saving $54,257.52 in mortgage interest. Your mortgage
will be paid off 5 years 9 months earlier.
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Two Step Mortgage
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A two step mortgage is essentially a 30 year mortgage with special
features: Convertible or non-convertible. These mortgage loans
are also known as 5/25s and 7/23s. The 5/25s has a fixed interest
rate for the first five years and then switches to either a 25
year fixed mortgage rate or a 1 year adjustable mortgage rate.
The 7/23 has a fixed interest rate for the first seven years and
then converts to a 23 year fixed or a 1 year adjustable. The starting
home loan rate is lower than a 30-year fixed. However, it is higher
than a 1-year ARM mortgage. This type of residential mortgage
is less risky than a mortgage ARM initially since the adjustment
interval is longer.
Federal Housing Authority (FHA) Mortgage
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A FHA mortgage is a residential loan insured by the FHA that is
part of the U.S. Department of Housing and Urban Development (HUD).
FHA loans have lower mortgage down payment requirements and were
easier to qualify for than conventional loans. The goal of the
FHA is to make housing affordable and stimulate demand.
The best feature of an FHA loan is the low downpayment. The down
payment mortgage can be as low as 2% but you will be required
to pay pmi private mortgage insurance. FHA loans are also assumable
so you can take over from the property seller if you qualify.
This could save you significant amounts of money and hassles.
The FHA mortgage loan amounts are determined by the median prices
of different cities within a specific region.
Veterans Affairs Loan
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The U.S. Department of Veterans Affairs guarantees mortgage loans
for veterans and service persons. It does not underwrite the residential
loans. The guaranty allows veterans to get home mortgage loans
with good borrowing terms, usually with little or no down payment.
To be eligible for the VA loan, you must have served 180 active
days service since September 1940. If you enlisted after September
7, 1980 you need to have two years of service. You do need to
get a certificate of eligibility from the Department of Veterans
affairs as proof of service.
Veterans are not permitted to pay points to the mortgage lender
on these types of mortgage loans. You can prepay a VA loan without
penalty and the residential loan is assumable, meaning the property
buyer can take over the mortgage if the property is sold. This
feature can save a buyer significant amounts of money in mortgage
interest payments. The buyer still needs to meet the requirements
of the current mortgage banker. The homebuyer takes over payment
on the existing mortgage and pays the difference between the mortgage
balance and the selling price. You should always verify first
whether the mortgage home loan you are securing is assumable.