All mortgage plans can be divided into categories in two different ways. Firstly, conventional and non-conventional loans.Any mortgage loan other than a VA, RHS or an FHA loan is conventional one. VA loans are guaranteed by U.S. Dept. of Veterans Affairs. The guaranty allows veterans and service persons to obtain home loans with favorable loan terms, usually without a down payment. In addition, it is easier to qualify for a VA loan than a conventional loan. Lenders generally limit the maximum VA loan to $359,700. The U.S. Department of Veterans Affairs does not make loans, it guarantees loans made by lenders. VA determines your eligibility and, if you are qualified, VA will issue you a certificate of eligibility to be used in applying for a VA loan. VA-guaranteed loans are obtained by making application to private lending institutions. If you are interesting in obtaining a VA-guaranteed loan see pamphlets published by VA.
The Rural Housing Service (RHS) of the U.S. Dept. of Agriculture guarantees loans for rural residents with minimal closing costs and no down payment. Visit our page RHS programs for details.
The Federal Housing Administration (FHA), which is part of the U.S. Dept. of Housing and Urban Development (HUD), administers various mortgage loan programs. FHA loans have lower down payment requirements and are easier to qualify than conventional loans. FHA loans cannot exceed the statutory limit. Go to FHA Programs page to get more information.
Ginnie Mae which is part of HUD guarantees securities backed by pools of mortgage loans insured by these three federal agencies - FHA, or VA, or RHS. Securities are sold through financial institutions that trade government securities.
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 results 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 announces new loan limits every year. The 2002 conforming loan limits are:
One-family: $300,700
Loans above the maximum loan amount are also known as 'jumbo' loans. Such loans often have a little higher interest rate than conforming because they are bought and sold on a much smaller scale. Loans that do not meet the borrower credit requirements are called 'B','C' and 'D' paper loans vs. 'A' paper conforming loans.
Secondly, all the various mortgage programs may be classified as fixed rate loans, adjustable rate loans and their combinations. 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 30 years, 20 years, 15 years and 10 years. 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.
The most popular mortgage term is 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. Besides, the shorter the term of a loan, the lower the interest rate you could get.
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 which involve small monthly payments (usually as 30 year loans) for a certain period of time and one large payment for the entire amount of the outstanding principal. Usually they have terms of 3,5, and 7 years.
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 requalified, nor the property reapproved. 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 a loan whose 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 indices include :
- 1. Treasury Security Indexes -- Yields on United States Treasury Securities adjusted to constant maturities. When using Treasury Securities, the ARM's adjustment period is usually the same as the security's constant maturity.
- 2. Treasury Bills -- Commonly called T-bills they come in denominations of 3 months, 6 months and 1 year. Depending on which three of these security index schedules you choose, the interest rate on your Adjustable Rate Mortgage (ARM) will adjust once every six months, once each year, or once every three years.
- 3. London Inter Bank Offering Rates (LIBOR) -- Interest rates at which international banks lend and borrow funds in the London interbank market.
- 4. Certificate of Deposit Indexes -- Average rates that you get when you invest in a 1- , 3- or 6-month CD.
- 5. 11th District Cost of Funds Index (COFI) -- This index reflects the weighted-average interest rate paid by 11th Federal Home Loan Bank District savings institutions for savings accounts and other sources of funds. ARMs based on this index can adjust every month, every six months, or every year.
- 6. Prime Rate -- An interest rate offered to banks best customers.
Historical and current values for some ARM's indexes are available. In the H15 Federal Reserve statistical release and in business newspapers.
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.
Example:
- The index is 5.3% and the margin is 2.5%,
- then the new interest rate = 5.3% + 2.5% = 7.8%.
- The nearest to 0.8% is 0.75% = 6/8%.
- The result will be 7.75%.
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.Examples:
1. The initial interest rate is 4.5%, the index is 7%, and the margin is 3%, then the new interest rate = 7% + 3% = 10%. If the lifetime cap is 5% then the actual new interest rate will be 4.5% + 5% = 9.5%.
2. The initial interest rate is 6%, the index is 5%, and the margin is 3%, then the new interest rate = 5% + 3% = 8%. If the periodic cap is 1% then the actual new interest rate will be 6% + 1% = 7%.
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.
Some types of ARMs offer payment caps, which limit the amount the monthly payment can increase. If a loan has payment cap but has no periodic interest rate cap, then the loan may become negatively amortized: if the interest rate increases and the monthly mortgage payment does not increase sufficiently then the payment does not cover the interest payment, so the loan balance increases. However, you always have the option to pay the minimum monthly payment, or the fully amortized amount due.
With most ARMs, the interest rate can adjust once a year, every three years, or every five years. The interest rate on negatively amortized loans can adjust monthly. 1-year ARM means a loan with an adjustment period of one year.
Some types of ARMs offer an initial lower interest rate than the fully indexed rate (index plus margin) for the first six month, or the first year. It is also known as teaser rate.
All ARMs are available with 30-year terms and some with 15-year terms.
Adjustable rate mortgages generally have a lower initial interest rate than fixed rate loans.
Combined loans come in different varieties: 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.
Two-Step mortgages have a fixed rate for a certain time, most often 5 or 7 years, and then interest rate changes to a current market rate. After that adjustment the mortgage maintains new fixed rate for the remaining 23 or 25 years. An other variant of the Two-Step mortgage offer a fixed rate for the first five, seven, or ten years, and then the interest rate adjusts annually.
A Buydown mortgage is another type of loan with an initially discounted interest rate which gradually increases to a higher fixed rate usually within one to three years. For example, a 30 year fixed loan with 8% interest rate and 6% initial discounted rate would have 6% interest rate for the first year, 7% for the second year, and 8% afterwards.
Some ARMs come with options to convert them to a fixed-rate mortgage at designated times, usually during the first five years on the adjustment date. The new rate is established at the current market rate for fixed-rate mortgages.
The other kind of mortgage is a fixed rate loan with rate reduction option. If rates had dropped since the time of closing it allows you, under some prescribed conditions, for a small conversion fee to adjust your mortgage to going market rate. Generally the interest rate or discount points may be a little higher for a convertible loans.
With a variety of different loan programs available, it is important to choose the type of loan that will best suit your needs.
The right type of mortgage chiefly depends on how long you plan on staying in the house and the amount of monthly payment you can comfortably afford.
If you don't plan to stay in your house for at least 5 to 7 years, it will be reasonable to consider an Adjustable Rate Mortgage, Balloon Mortgage or Two-Step Mortgage. An ARMs traditionally offer lower interest rates during the early years of the loan than fixed-rate loans. A Two-Step Mortgage will give you a lower interest rate than a 30-year mortgage for the first five or seven years. A Balloon Mortgage offers lower interest rates for shorter term financing, usually five or seven years. Because of a lower interest rate it is easy to qualify for these type of mortgages. However don't accept the ARM unless you can afford the maximum possible monthly payment.
Generally, you can start to consider 15 or 30 year fixed rate mortgages if you plan to stay in your home for more than seven years.