A home is usually the most valuable asset for a family. The home for many people symbolizes the juncture in life, when they have ‘settled’ and established themselves financially. The possession of a home is often an indicator to many lenders that the borrower is financially sound and it is safe to give him/her a loan or line of credit.
Apart from the actual market value of the home, it is also the peace of mind that ownership brings, which is invaluable. With your own home, you are no longer at the mercy of landlord for the roof over your head, you are protected from rising rental costs, and you have the freedom to design and remodel your living areas to accommodate your every need, no matter how eccentric they may seem to outsiders.
An owned home is a huge asset to fall back on in hard times. Apart from the funds you can get by its sale, it can also be used as a means of generating recurring income if you let it out and move to smaller accommodation.
However, not everyone can afford to make the substantial investment that home buying entails. This does not have to be a deterrent. With the many different mortgage products available in the market, there is practically a loan to suit every need and situation.
A mortgage allows the owner to take a loan using the home as collateral. In return for the funds, the buyer pays interest at an agreed rate to the lender. Mortgages not only help buy new homes but also allow owners to use their investment in the home optimally. Let us take a look at the various types of mortgages in the market.
Navigation of the Different Types of Mortgage Loans
1. Fixed Rate Mortgage Loans
2. Adjustable Rate Mortgage Loans
3. FHA Mortgages Loans
4. VA Mortgages Loans
5. Creative Financing Loans or Seller Assisted Mortgage Loans
6. Interest Only Mortgage Loans
7. Combo Loans or Piggyback Mortgage Loans
8. Mortgage Buydown Loans
9. Streamlined K Mortgage Loans
10. Bridge Mortgage Loans or Swing Mortgage Loans
11. Equity Mortgage Loans
12. Reverse Mortgages Loans
13. Balloon Mortgage Loans
14. First Time Buyer Loans
1. Fixed Rate Mortgage Loans
These mortgages generally cover a period of 15 to 30 years and come at a rate of interest fixed at the time of the loan agreement. The same rate of interest applies through the entire term of the loan irrespective of how market rates change.
Fixed rate mortgages are preferred for many reasons. The borrower is insulated from fluctuations in prevailing interest rates with this kind of mortgage loan. When the interest rates are expected to go up in near future or when rates are at an all time low, it is advisable to opt for this kind of mortgage. This will give you significant gains when rates soar because you will be paying interest at a lower rate than the rates prevailing in the market.
Another advantage of a fixed rate loan is that the monthly due towards the loan is known beforehand. This makes it easy to arrange for funds to meet this expense in advance and avoid missed or late payments, which may add to your costs and hurt your credit score.
The interest rate for a fixed rate mortgage may be higher than that of variable or adjustable rate mortgages. The higher rate protects the lender from heavy losses in case of a sharp increase in interest rates in future.
2. Adjustable Rate Mortgage Loans
In an adjustable rate mortgage, the interest rate is ‘adjusted’ or modified at periodic intervals. An index may be used as the basis for this adjustment by some lenders while others use their interest rate payable as a benchmark. The premise is to allow the interest rate to mimic prevailing market lending rates so that both the lender and borrower benefit at different times.
If the rate fixed at the beginning of the loan is much lower than prevailing rates, then the lender can make up for the loss of interest by hiking the interest rate on the adjustable rate mortgage. The borrower benefits when he signs up for a high rate mortgage and subsequently the market rates decline steeply, causing his/her mortgage rate to go down too. Instead of continuing to make high interest payment, as with a fixed mortgage, the borrower benefits when the rates are adjusted to match the low prevailing level.
An adjustable rate mortgage is a good option for the borrower when prevailing interest rates are high and are expected to fall.
Usually, adjustable rate mortgages come with an initial fixed rate lock in period during which the rate does not change. Beyond this time limit, the rates are adjusted in accordance with the conditions stated in the loan agreement.
As the risk of increasing rates is transferred to the borrower in the case of an adjustable or variable rate mortgage, these loans usually have lower initial interest rates.
3. FHA Mortgages Loans
These mortgages are insured by the Federal Housing Administration. Federally qualified lenders give these loans. These loans enable low income families to fulfill the dream of owning a home. A low down payment is one of the chief advantages of these FHA loans. The most attractive FHA loan has a down payment of only 3.5%. The down payment largely depends on the borrower’s credit score, with good scores requiring less payment than damaged scores. FHA loans are easy to qualify for and are backed by the government, which makes them doubly attractive to borrowers.
The first FHA loan was introduced during the Great Depression in the 1930s. Back then, it was aimed at boosting the confidence levels of the general public by making home buying a possibility even for low income earners. Although it initially began as a government backed program, it later turned into a self sufficient program with the FHA insurance bringing in enough funds in the form of premiums from home buyers.
Although these loans are known as FHA loans, the FHA is not the lender. It provides the borrower with the backing he/she needs to acquire low cost loans. The FHA studies the borrower’s financials and agrees to insure his/her loan if the scrutiny yields satisfactory results. Because the FHA insures the loan, the lender’s risk in the event of default by borrower is greatly lowered.
There are many different kinds of FHA loans and the borrower can opt for the most suitable one. With the recent changes to FHA policy, lenders approved by this agency are required to disclose their list of borrowers along with the loan status. Prospective borrowers can see how many of the lender’s loans are being repaid on time, how much outstanding balance they have accumulated and how many defaults have occurred. This helps the borrower gauge the lender’s financial stability.
4. VA Mortgages Loans
The VA mortgage loan is guaranteed by the US Department of War Veterans. American war veterans or their surviving spouses can avail of these loans to purchase homes. In order to qualify for one, the veteran must obtain a Certificate of Eligibility from the Veterans Department. The advantage of a VA loan is that the borrower can qualify for bigger loans than is possible within the regular lending system.
As with the FHA loan, the VA insures the lender against default by the veteran. Because of this guarantee by the government department, mortgage lenders are willing to lend at lower rates to those who qualify for VA insurance. When you apply for a VA loan, the property you wish to purchase is appraised by a VA authorized appraiser. This appraiser arrives at a reasonable value of the property in question. Based on this assessment your loan application is approved for insurance by the VA.
Eligible borrowers can opt for these loans to buy homes with no down payment in 90% of the cases. This program is beneficial in areas like small towns or rural locations where veterans cannot avail of private lending schemes.
The VA also offers loan counseling and guidance to keep veteran borrowers from defaulting on their repayments. This assistance comes in the form of representing the borrower in negotiating for easier terms of payment with the lender.
5. Creative Financing Loans or Seller Assisted Mortgage Loans
As the name suggests, in this type of loan, the seller assists the buyer in purchasing the home. The seller may do this by underwriting a portion of the loan. In some cases, he may underwrite 100% of the loan. Some sellers may offer to reduce the interest rates and keep the down payments unchanged. Whatever be the terms, creative financing or seller assisted mortgage is a loan that calls for the participation of both the seller and buyer of the property.
This kind of loan keeps the loan dealings between the two most involved parties in the deal. This means that the repayment of the loan is in the best interest of both and so both the seller and buyer will work towards the same goal, resulting in a higher possibility of successful repayment of the loan.
Seller assisted financing is especially beneficial for sellers of property, which has remained on the market for a long time. By offering assisted financing, the property can be made more attractive to buyers and thus may sell quickly. The seller also has the flexibility to determine how to best structure the assistance program based on the prospective buyer’s ability to pay.
This kind of mortgage loan is usually cheaper than other options available in the market. There are some downsides to this kind of loan. The ownership documents will continue to be held by the seller until you pay back the loan in full. In many cases, these loan options have been found suitable only for short term financing needs with borrowers having to resort to external refinance loans to meet the creative financing deal.
6. Interest Only Mortgage Loans
An interest only mortgage is a loan where for a specified period of time, the payments made by the borrower fulfill only the interest charged on the loan. The principal amount is not paid back during this period. This results in the repayable principal amount remaining at status quo when the interest only period comes to an end. At this point, the principal is amortized over the rest of life of the loan. The borrower may also opt for full repayment of the principal now to repay the entire debt. In the US, interest only periods are typically 5 or 10 years for these kinds of loans. The main advantage of this loan is the low monthly payments that are required during the initial years.
Some lenders allow the borrower to add an extra payment to interest only payments and reduce the principal amount during the initial period. If so, the borrower can use unexpected gains from other sources during the interest only period to reduce the principal outstanding.
Interest only loans are beneficial for those who are just starting out in their careers. A young borrower with good higher education can, for instance, opt for this loan. He/She bases his/her calculations on the fact that he/she is likely to progressively earn more salary as the work experience grows. Given this, by the time the interest only period ends he/she would be able to maintain higher amortized principal plus interest repayments.
This kind of loan is also appealing to investors who have long term investments maturing at the end of the interest only period. They take advantage of smaller monthly repayments until the interest only period ends and then use the proceeds from maturity of the long term investments to pay back the principal amount.
7. Combo Loans or Piggyback Mortgage Loans
A piggy back mortgage or a combination mortgage is one where a buyer uses two mortgages simultaneously to finance his/her home. Usually, buyers do this when they want to avoid or reduce the Private Mortgage Insurance or PMI that they have to incur for availing of mortgage loans.
A mortgage loan that covers more than 80% of the home value requires the borrower to take a PMI. This insurance covers the lender’s risk. In case the borrower defaults on his/her repayments, the insurer is bound by this PMI agreement to make up for the loss to the lender.
For the borrower, the insurance requirement adds just another cost to his loan. In order to avoid paying the PMI, borrowers limit their first mortgage to 80% of the home’s value. A second mortgage is taken to cover around 10 to 15% of the value leaving the home buyer with 5% to 10% to pay as down payment. The most common piggyback ratio is 80-10-10 with some buyers opting for an 80-15-5 break up.
Some buyers may opt for seller assisted loans to cover the second mortgage and the down payment. Considering that second mortgages are typically higher interest than first loans, this loan may be expensive. It is important to calculate accurately the costs of the second mortgage – its processing fees, charges plus interest payable. Compare this figure with the PMI payments you will need to make on a single full mortgage to cover the entire purchase. If you still stand to save significantly by opting for the second mortgage then look for lenders else stick to PMIs with one single mortgage.
8. Mortgage Buydown Loans
A mortgage buydown is a loan where the cost of the mortgage is brought down by an understanding between the lender and borrower. This may be in the form of lower interest rates than prevailing in the market for the term of the loan. It may also be in the form of a short term low interest holiday on the loan beyond which period the normal market rate prevails.
The lender is enabled to offer such ‘soft’ terms in two ways. One, he may be offered some discount points from the builder or seller of the property. In exchange for these discount points, he offers better rates than normal to the borrower. Two, the borrower may be able to manage a substantial lump sum down payment in exchange for a lower interest rate for the loan.
For the borrower the lower costs of the loan are an obvious advantage. If he has the means to make a lump sum payment, he can make the best of the low recurring costs for the duration of the loan. Even if he opts for a plan, which offers low interest rate only for an initial period, he still stands to gain. As he makes repayments, his principal loan amount keeps diminishing. Subsequent interest payments are calculated on this diminished amount. By opting for low initial interest, the borrower pays low interest when the principal is highest. By the time the loan is readjusted to a higher rate, his principal amount is substantially reduced and the higher rate applies on this amount.
The lender also benefits by reducing their risk because of the high down payment. If the lender is offering low interest rates, then they are likely to attract more borrowers, which is good for their business.
9. Streamlined K Mortgage Loans
When a prospective buyer wants to purchase an older home that may need extensive repairs to make it livable, the Streamlined K Mortgage loans can be very helpful. Often older homes on the market fail to find buyers quickly even if they are in prime location because of their condition. Some older homes may have older utility systems that are no longer in use for convenience or safety reasons. In these cases, a new owner may have to bear some substantial costs to repair or modify the home before he can actually begin to live there. These costs put off prospective buyers.
With the Streamlined 203(k) limited repair program, the buyer can avail of an additional $35,000 in their mortgage loan towards these costs. Recent modifications to the law have removed the minimum permissible repair limits and raised the maximum ceiling from $15,000 to $35,000. The greatest advantage of this program is that no professional consultation or assessment by engineers or architects is required to qualify for the financial aid. If the repair exceeds $15,000, the buyer will have to ensure that all the repairs listed at the time of availing the loan are completed.
The Streamlined 203 (k) program aims at making repairs and rehabilitation much simpler and easier to finance so that older homes may find buyers quickly. This loan covers an exhaustive array of repairs but there are a few exceptions. Structural changes, removing load bearing walls or addition of rooms are not permitted under this program.
10. Bridge Mortgage Loans or Swing Mortgage Loans
A bridge loan covers the financial need of the borrower until he/she can arrange for a longer term loan, or a pre arranged longer term loan can come into effect. The loan is usually backed by your home as collateral. This kind of loan is also known as ‘gap financing’, ‘interim financing’ or ‘swing loan’.
The second and longer term loan is used to pay back the bridge loan. Generally, bridge loans are normally high interest loans, because they afford quick financing to meet an immediate need. A typical bridge loan may be for a one year term.
These loans are processed quickly so that the borrower can get the funds in the minimum possible time. The most common use for bridge loans is when a buyer wants to use the sale proceeds of his existing home to purchase a new one. In many cases, the new house may need to be paid for quickly to ensure that it is not sold off to another interested party. It is a difficult task to synchronize the sale of the old house with the purchase of the new one so that the funds can directly be taken out of one and put into the other. In this case, the buyer opts for a bridge loan to cover the cost of purchasing the new home. As soon as the old one is sold, the proceeds are used to pay off the bridge loan.
The buyer must use great caution while opting for a sale-purchase deal like this using a bridge loan. He must consider the consequences of any delay in selling the old home, in which case he cannot pay off the bridge loan within the expected time. The high interest charged for the bridge loan translates into huge costs, which will extend indefinitely until the old house is sold.
11. Equity Mortgage Loans
An equity mortgage loan or a home equity loan lets you use the equity you have built up in your home for getting a loan. If the home is substantially paid for then this loan can open up a large source of funds for you. As these loans are backed by the home, the lender’s risk is greatly reduced. This is why such loans may be a good option for borrowers with compromised credit scores who find it difficult to find no-collateral loans.
The equity mortgage loan is usually a second mortgage on the home. The lender bases his loan on the market value of the property less any first mortgage outstanding to determine exactly how much he can recover in case of default. In a market where the housing values are rising, you can avail of bigger equity loans and vice versa. Because the lender can simply sell the property to make good his loan, he is willing to offer lower rates of interest on this kind of loan.
The equity mortgage loan is a good way to finance home improvements or repairs to the home. For one, this loan affords enough funds to cover even major costs and second, the equity in the home is used to improve the value of the same asset. However, many home owners do use these loans for other large financing needs like education, debt consolidation, medical treatment or even buying a second home.
12. Reverse Mortgages Loans
A reverse mortgage is another loan, which allows the borrower to use his/her paid up equity in the home. Typically, these loans are availed for homes that are completely paid off and owned fully by the borrower. With a reverse mortgage, the borrower increases his debt over time rather than making payments to reduce it. The loan may also be in the form of one single lump sum payment based on the equity in the home.
Elderly persons and retirees often use these loans as a means to finance their expenses in the later stages of life after they have passed the age of earning a regular income. The reverse mortgage conditions stipulate a minimum age of 62 to qualify for these loans. The home, which forms the basis of the mortgage, must be the primary residence of the borrower. The reverse mortgage will continue to be in force until the borrower moves out of the home, the home is sold or until the lifetime of the borrower.
For elderly home owners, the reverse mortgage is a good way to fund sudden big expenses like medical treatment. They can also opt for a regular periodic payout to meet the recurring living expenses. This compensates for the lack of regular salary income.
13. Balloon Mortgage Loans
A balloon mortgage can be described as a fixed mortgage for a limited period followed by a lump sum pay back of the outstanding loan balance. The initial interest rate is fixed at the time of commencement of the loan. This interest rate is in force until the initial term, say 5 to 7 years, expires. At this point, the balance due on the loan must be paid back in full. Borrowers may have to take a refinance loan to make this payment.
For borrowers who are expecting a lump sum receivable at the time of balloon payment, the balloon mortgage is a good deal. Those with investments maturing at around this time can also pay off the lump sum without difficulty. Investors may opt to buy houses in prime localities with balloon loans. The premise is that the home value will have risen substantially by the time the balloon payment has to be made. At this point, the borrower hopes to sell the home, make good the loan and still gain because of the value improvement.
A balloon loan offers the borrower some insulation from fluctuating market rates for the initial period. At the time of the balloon payment, he can opt for an adjustable or fixed rate mortgage to refinance the dues, taking full advantage of the interest rate scenario at that time. But if the interest rates are at an all time high, then the borrower could end up increasing the costs of his home loan significantly.
14. First Time Buyer Loans
First time buyer loans are aimed at making the purchase of the first home easier and less of a financial burden for borrowers. The loan may also be extended to people who have not owned a home in a pre specified number of years immediately preceding the loan application, say 3 years.
This kind of loan offers low down payment, reduced interest rates, and subsidized fees to make sure that the borrower gets the best deal on the loan so that he is encouraged to buy the home. In conjunction with government programs like the recent First Time Home Buyer Credit Program, which offered tax benefits to the home buyers, this loan can cut costs dramatically for the borrower.
The first time buyer loans are financial assistance schemes primarily designed for lower income families. This means that you may not be able to avail of this loan to purchase a high end condominium in the most elite part of the town. There are also some restrictions on the total value of the home bought. The home must be used as your primary residence for you to be qualified for the loan.
In effect, these loans allow many low income Americans to own a home, which they otherwise may not have been able to afford.
With so many mortgage choices and each bringing some special features and advantages, it is not a difficult task to find a loan that perfectly matches your needs. It is necessary to understand the terms and conditions of any loan you are going to sign up for. This will help you avoid any hidden fees or unexpected charges that can prove to be very costly at a later date when you are already committed to repayment.
It is also a good idea to look at more than one lender to find the best rates and terms. With the housing segment remaining subdued post recession, the time is just right for buying your dream home.
