TYPES OF MORTGAGE LOANS:
A wide selection of mortgages are available to you nowadays. Your challenge is to select
the loan terms that are most favorable to your situation.
If, for example, you anticipate living in your home
for many years, the interest rate may be the main factor for you. If you expect to
keep the house for only a short period of time, the closing costs may be more important to
If you want to have ended any mortgage debt by the
time you are facing your children's college bills or your own retirement, you may wish to
consider a shorter term loan such as a 15-year fixed-rate mortgage. If your own
retirement is years away, you may be less inclined toward a shorter-term loan, preferring
to extend payments over a longer period of time through taking on a 30-year mortgage loan.
How important to you is the certainty of a fixed
mortgage payment each month? If you want to make sure your mortgage payment remains the
same each month, then you'll want to focus on various fixed-rate loans. If you are
comfortable with periodic changes to your mortgage interest rate, then you may be inclined
to consider adjustable-rate mortgages.
The interest rate may be your main consideration if
you expect to stay in your house for a long time. With a fixed-rate mortgage, you can be
sure that your interest rate will stay the same for the entire life of your loan.
Fixed-rate mortgages are available in a variety of repayment terms, with 15, 20, and 30
years the most common.
The easiest fixed-rate loan to qualify for, the
30-year mortgage gives you an excellent opportunity to keep your mortgage payments
reasonable by making monthly payments over a long period of time. This mortgage loan may
be ideal if you plan to remain in your home for years and wish to keep your housing
expense low and use any extra cash for other purposes. This loan also provides maximum
interest deduction for tax purposes.
The 20-year mortgage gives you the opportunity to
own your home free of debt much sooner than the 30-year mortgage loan. It often offers a
lower interest rate compared to a 30-year loan. This mortgage amortizes principal and
interest over a 20-year period, 10 years less than the traditional 30-year mortgage. This
may save you a considerable amount of total interest paid over the life of the loan.
The 15-year mortgage offers a lower interest rate
than a 30-year or 20-year mortgage. Such a shorter-term mortgage will save you a
significant amount of interest over the life of the loan. By paying off the mortgage more
quickly, you also build up equity in your home sooner. A 15-year mortgage can let you own
your home clear of debt earlier, which may be important if you are approaching retirement
or have other large expenses to cover such as financing your children's education.
However, the monthly payments you make on a 15-year mortgage will cost you more than those
you would make on a 30-year or a 20-year mortgage loan for the same total mortgage amount.
With an adjustable-rate mortgage (ARM), the interest
rate you pay is adjusted from time to time to keep it in line with changing market rates.
This means that when interest rates go up, your monthly mortgage payments may go up as
well. On the other hand, when interest rates go down, your monthly mortgage payments may
also go down.
ARMs are attractive because they may initially offer
a lower interest rate than fixed-rate mortgages. Since the monthly payments on an ARM
start out lower than those of a fixed-rate mortgage of the same amount, you can qualify
for a larger loan. The chief drawback, of course, is that your monthly payments may
increase when interest rates go up.
You may want to consider an ARM if you are confident
your income will rise enough in the coming years to comfortably handle any increase in
payments. You may also want to consider an ARM if you plan to move in a few years and
therefore are not so concerned about possible interest rate increases. You may also want
to consider an ARM if you need a lower initial rate to afford to buy the home you want.
How much your payments can increase will depend on
the terms of your mortgage. Before applying for an ARM, be sure you know how high your
monthly payments could go -- the so-called "worst-case scenario." An ARM has two
"caps" or limits on how large an interest rate increase is permitted: One cap
sets the most that your interest rate can go up during each adjustment period and the
other cap sets the maximum total amount of all interest adjustments over the life of the
A typical ARM that adjusts annually, for example,
may cap the yearly interest rate increases at 2 percent, meaning that the adjusted
interest rate can never be more than 2 percent higher than the previous year. And such an
ARM may have a lifetime rate cap of 6 percent, meaning that the highest adjusted interest
rate you can ever be required to pay is no more than 6 percent above the original rate.
So, if you are looking at an ARM with a current introductory rate of 5 percent, a lifetime
cap of 6 percent tells you that the highest interest rate you could ever pay would be 11
percent. Only you can determine if you would feel comfortable paying this interest rate
sometime in the future.
Some ARMs offer a conversion feature, which allows
you to convert from an adjustable-rate to a fixed-rate loan at only certain times during
the life of your loan. Ask your lender about this feature when researching ARMs.
One important thing to know when comparing ARMs is
that the interest rate changes on an ARM are always tied to a financial index. A financial
index is a published number or percentage, such as the average interest rate or yield on
Treasury bills. The most common types of ARMs are listed below.
(Certificate of Deposit)
These ARMs adjust to a Certificate of Deposit (CD)
index. After an initial six-month period, the initial rate and payments adjust every six
months. These ARMs typically come with a per-adjustment cap of 1 percent and a lifetime
rate cap of 6 percent. Some of these ARMs offer an option to convert to a fixed-rate
mortgage at specified interest adjustment dates.
These ARMs are indexed to the weekly average yield
of U.S. Treasury securities adjusted to a constant maturity of six months, one year, or
three years. Depending on which three of these security index schedules you choose, the
interest rate on your ARM will adjust once every six months, once each year, or once every
three years. Per-adjustment caps and lifetime rate caps vary, depending on the type of
Treasury-indexed ARM you choose. Some of these ARMs offer an option to convert to a
fixed-rate mortgage at specified interest adjustment dates.
Cost of Funds-indexed (COFi) ARMs are indexed to the
actual costs that a particular group of institutions pays to borrow money. The most
popular index of this type is the COFi for the 11th Federal Home Loan Bank District. COFi
ARMs can adjust every month, every six months, or every year and the per-adjustment caps
and lifetime rate caps vary, depending on the type of COFi ARM you choose. Some of these
ARMs offer an option to convert to a fixed-rate mortgage at specified interest adjustment
The London Interbank Offered Rate (LIBOR) is the
interest rate at which international banks lend and borrow funds in the London interbank
market. You may choose an ARM that adjusts to the LIBOR every six months. This six-month
LIBOR ARM typically has a per-adjustment period cap of 1 percent and is offered with
either a 5 percent or a 6 percent lifetime rate cap. It can offer the option to convert to
a fixed-rate mortgage.
You may wish to look into a special type of ARM that
doesn't adjust your interest rate until several years after you take out the loan. These
loans offer you several years of fixed payments before there is an interest rate change.
You can get a three-, five-, seven-, or ten-year fixed-period ARM. This means your
interest rate would be the same for the first three, five, seven, or ten years and then,
at the end of your chosen fixed-rate period, your interest rate would adjust every year.
This type of ARM protects you against rapid interest rate increases in the early years of
The Two-Step is a special type of ARM because it
adjusts only once - either at seven years or at five years. After that initial adjustment,
the mortgage maintains a fixed rate for the remaining 23 or 25 years of a 30-year mortgage
repayment term. For example, if your initial interest rate were 8 percent, you would pay
that rate for the first seven (or five) years. Then, for the remaining 23 (or 25) years,
you would pay an interest rate that is indexed to the value of the 10-year U.S. Treasury
security on the adjustment date. This new rate can never be more than 6 percentage points
higher than your old rate. There are no limits on how much lower the adjusted interest
rate can be.
The Two-Step, then, provides the benefit of initial
low rates with the stability of longer term financing. If you continue living in your home
beyond the loan adjustment date, the Two-Step offers the assurance of a fixed rate for the
remaining term of the loan. At the adjustment date, there is no additional refinancing
cost, no forms to complete, and no re-qualification necessary.
The Federal Housing Administration (FHA), the U.S.
Department of Veterans Affairs (VA), and the Rural Housing Services (RHS) are three
agencies that offer government-insured loans. To obtain these loans, you apply through a
lender that is approved to handle them. All require that the properties being purchased
meet certain minimum standards.
Here is some more information about various
government loan programs:
With FHA insurance, you can purchase a home with a
very low down payment (from 3 percent to 5 percent of the FHA appraisal value or the
purchase price, whichever is lower). FHA mortgages have a maximum loan limit that varies
depending on the average cost of housing in a given region.
The VA guarantee allows qualified veterans to buy a
house costing up to $203,000 with no down payment. Moreover, the qualification guidelines
for VA loans are more flexible than those for either FHA or conventional loans. If you are
a qualified veteran, this can be an attractive mortgage program. To determine whether you
are eligible, check with your nearest VA regional office.
The Rural Housing Service, a branch of the U.S.
Department of Agriculture, offers low-interest-rate homeownership loans with no down
payment requirements to low- and moderate-income persons who live in rural areas or small
and Local Loan Programs
A number of states sponsor programs to help
first-time home buyers qualify for mortgages. Local housing agencies also offer attractive
loan terms to eligible home buyers in some areas. These programs typically offer very
attractive loan terms (low down payment or low interest rate) to first-time home buyers
who meet specified income guidelines. Some state and local programs may also offer down
payment and closing cost assistance.
Balloon loans offer lower interest rates for shorter
term financing, usually five, seven, or ten years. At the end of this term, they require
refinancing or paying off the outstanding balance with a lump-sum payment. Balloon
mortgages may be suitable if you plan to sell or refinance your home within a few years
and want a fixed, low monthly payment. The advantage they offer is an interest rate that
is lower than that of a fully amortizing fixed-rate mortgage. For example, your initial
interest rate may be 7.5 percent, and you would pay that rate for the first five, seven,
or ten years (depending on the term of your balloon loan). Then, your entire outstanding
loan balance would be due to the lender or you might have to pay a fee to refinance your
loan at the prevailing interest rate. However, ask about all the conditions for a
refinance option at the end of the balloon term. With some balloon mortgages, the lender
doesnt guarantee to extend the loan past the balloon date. If you dont
feel you will be able to meet all the refinance conditions or think the balloon term may
be up before you are ready to move, this type of loan may not be appropriate for you.
For households of modest means, the greatest
barriers to homeownership are coming up with the down payment and closing costs and
managing housing expenses that often are higher than those of the qualifying guidelines
allowed in traditional mortgage lending.
Fannie Mae, in cooperation with housing providers,
offers low- and moderate-income households mortgage loan options that help overcome common
barriers to homeownership. These mortgage loans offer flexible underwriting ratios,
allowing you to use more of your monthly income toward housing costs than other mortgage
loans allow. Also, these loans require less cash at closing and for a down payment, making
it easier to get into a home sooner.
Mae's Community Home Buyers Program®
Fannie Mae's Community Home Buyers Program
provides financing for low- and moderate-income home buyers who represent a good credit
risk but who might not qualify for home financing based on traditional lending criteria.
Generally, if your household income is no more than 100 percent of your area median
income, you are eligible for this type of loan. However, if the home you buy is in certain
geographical areas, there is no income limit to be eligible for this program.
The Community Home Buyers Program builds
flexibility into the lenders standard lending requirements. This increases your
purchasing power and decreases the total amount of cash needed to purchase a home.
The same flexibility also allows you to build a
nontraditional credit history. For example, if you do not have a credit history that is
reflected in a credit report, your demonstrated willingness and ability to repay on a
timely basis may be documented by verifications from utility companies, current and
previous landlords, and other sources of credit or service where you were, or still are,
required to meet a regular financial obligation.
An important feature of the Community Home
Buyers Program is the 3/2 Option. The 3/2 Option makes it easier for you to
accumulate the minimum down payment necessary to obtain a mortgage. By taking advantage of
the 3/2 Option, you can buy a home with a 3 percent down payment of your own funds instead
of the 5 percent down payment usually required by lenders. The remaining 2 percent of the
down payment can be supplied by a relative as a gift, or it can come from a nonprofit
organization or a state, federal, or local government program in the form of a grant. To
be eligible for the 3/2 Option, your household income, in most cases, may not exceed 100
percent of your area median income.
The Fannie 97 mortgage lets you buy a house for as
little as a 3 percent down payment. This type of mortgage may be ideal for the
borrower who has enough income to handle the monthly mortgage payments but has difficulty
accumulating cash for the down payment. The mortgage is available only to home
buyers earning up to 100 percent of the area median income, with exceptions for certain
high-cost areas and where the loan is made in connection with a federal, state, or local
government program, where income limits are legislatively imposed. The mortgage is
available with either a 25-year or 30-year term. With Fannie 97, closing costs may
be paid by gifts from family members or by grants or loans from nonprofit organizations or
FannieNeighbors provides added flexibility to the
CHBP by removing the income limit if you are purchasing a home within a designated central
city or eligible census tract.
A central city is defined by the U.S. Office of Management & Budget (OMB) to be the
largest city in a metropolitan area and other additional cities that have populations of
at least 250,000 or meet certain criteria for employed residents living in a city. A
census tract is defined as an area with a population that is at least 50 percent minority
or an area that has a median income at or below 80 percent of the median family income for
the Metropolitan Statistical Area (MSA).
However, the income limit is not removed if you are using FannieNeighbors with the 3/2
Option or Fannie 97.