There are literally thousands of loan programs available in the market. Every lender tries to be as different as they can to create a special niche, which they hope will increase business. It would be impossible to provide a review of every type of loan, so in this article, we’ll just stick to the main ones. Most loan programs are variations of the loans we will cover here. First of all we will go over some terminology you should understand and then we will delve into the different mortgage programs available today.
Amortization is the paying back of the money borrowed plus interest. The actual term, or length of the mortgage along with the amortization is what determines what the payments will be and when the loan will be paid off. It is a means of paying out a predetermined sum (the principal) plus interest over a fixed period of time, so that the principal is completely eliminated by the end of the term. This would be easy if interest weren’t involved, since one could simply divide the principal amount into a certain number of payments and be done with it. The trick is to find the right payment amount,which includes some principal and some interest. The formula of amortization uses only 12 days a year to compute the interest. The interest payment on a mortgage is calculated by multiplying 1/12th (one-twelfth) of the interest rate times the loan balance of the previous month.
On a 30-year, $150,000 mortgage with a fixed interest rate of 7.5 percent,a homeowner who keeps the loan for the full term will pay $227,575.83 in interest. The lender does not expect that person to pay all that interest in just a couple of years so the interest is spread over the full 30-year term. That keeps the monthly payment at $1,048.82.
The only way to keep the payments stable is to have the majority of each month’s payment go toward interest during the early years of the loan. Of the first month’s payment, for instance, only $111.32 goes toward principal. The other $937.50 goes toward interest. That ratio gradually improves overtime, and by the second-to-last payment, $1,035.83 of the borrower’s payment will apply to principal while just $12.99 will go toward interest.
There are four types of loans when dealing with amortization and term. They are:
1. Fixed: with conventional fixed rate mortgages, the interest rate will stay the same for the life of the loan. Consequently the mortgage payment (Principal and Interest) also stays the same. Changes in the economy or the borrower’s personal life do not affect the rate of this loan.
2. Adjustable: (ARM) also called variable rate mortgages. With this loan the interest rates can fluctuate based on the changes in the rate index the loan is tied to. Common indexes are 30 year US Treasury Bills and Libor (London Interbank Offering Rate). Interest rates on ARMs vary depending on how often the rate can change. The rate itself is determined by adding a specific percentage, called margin, to the rate index. This margin allows the lender to recover their cost and make some profit.
3. Balloon: A loan that is due and payable before it is fully amortized. Say for example that a loan of $50,000 is a 30-year loan at 10% with a five-year balloon. The payments would be calculated at 10% over 30 years, but at the end of the five years the remaining balance will be due and payable. Balloon mortgages may have a feature that would allow the balloon to convert to a fixed rate at maturity. This is a conditional offer and should not be confused with an ARM. In some cases, payments of interest only have to be made, and sometimes the entire balance is due and the loan is over. Unpaid balloon payments can lead to foreclosure and such financing is not advisable to home buyers. Balloons are used mainly in commercial financing.
4. Interest only: This type of loan is not amortized. Just like the name implies the payments are of interest only. The principal is not part of the payment and so does not decline. Interest-only loans are calculated using simple interest and are available in both adjustable-rate loans and fixed rate loans.
Fixed-rate: The fixed-rate loan is the benchmark loan against which all other loans are compared to. The most common types of fixed rates loans are the 30 year and the 15 year loans. The 30-year loan is amortized over 30 years or 360 payments while the 15 year is amortized over 180 payments. For the borrower, the 15 year loan has higher payments, since the money needs to be repaid in half the time. But because of that same feature the interest paid to the bank is much lower as well.
Although these two terms are the most common, others are gaining in popularity, such as 10, 20, 25 and even 40-year term loans.Depending on the lender, the shorter the term, the less risk there is and therefore plus rate.
Other types of fixed rate loans:
The bi-weekly mortgage shortens the loan term of a loan from 30 years to 18 or 19 years by requiring payment for half of the monthly amount every two weeks. Bi-weekly payments increase the annual amount paid by about 8 percent and actually pay 13 monthly payments (26 bi-weekly payments) per year. The shortened loan term greatly reduces the total cost of interest.
However, the bi-weekly mortgage interest charges are further reduced by applying each principal payment on which interest is calculated every 14 days. By nibbling away the principal faster, the owner saves additional interest. The ability to qualify for this type of loan is based on a 30-year term, and most lenders who offer this mortgage will allow the buyer to convert to a more traditional 30-year loan without penalty.
GRADUATED PAYMENT MORTGAGE (GPM)
This loan is a good idea for buyers who expect their income to increase in the future. A GPM will start these borrowers at a much lower interest rate than the market. This allows them to qualify for a larger loan than they otherwise would. The risk is that they assume that they will have enough income to pay higher payments in the future. This is similar to an ARM but the rate increases to a fixed rate, not like the ARM where the rate is based on the market. For example, a 30-year GPM could start with an interest rate of 5% for the first 6 months, adjust to 7% for the following year, and adjust upward 0.5% every 6 months. thereafter.
GROWING EQUITABLE MORTGAGE (GEMS)
As long as mortgages have existed, conventional fixed loans have been the standard against which creative financing has been measured. In the early 1980s, GEM was developed as a new alternative to creative finance. The GEM loan, although amortized like a conventional loan, uses a unique repayment method to reduce interest charges by 50% or more. Instead of paying a fixed amount each month, GEM loans have a gradual payment increase which can be calculated by increasing the monthly payment by 2, 3, 4 or 5 percent per year during the loan. Or the monthly payments can be set to increase based on the performance of a specific market index.
So far, it looks like a progress payment mortgage, but there is a difference. As the monthly payments increase, any extra money paid by borrowers is used to reduce the principal balance. This results in a loan paid off in less than 15 years.
While a reverse mortgage isn’t exactly a fixed rate mortgage (it’s more of an annuity), I’ve included it here because the payments to buyers are fixed. Reverse mortgages are specially designed for seniors with equity in their home but limited cash flow. They allow individuals to keep their property while providing the necessary liquidity. In a traditional mortgage, homeowners pay off the amount borrowed over a specified period of time. With a reverse mortgage, the homeowner receives a set amount each month.
To illustrate, let’s say Mr. and Mrs. Smith are 70 and 65, respectively, and retired. Their house is free of charges and is worth $ 135,000. They would like to take the money out of their home to enjoy it, but instead of getting it all at once by refinancing it, they want to get a little bit each month. Their lender arranges a reverse mortgage for $ 100,000. They will receive $ 500 per month on their equity and the lender will earn 9% interest.
Unlike other mortgages where the same $ 100,000 is only the principal amount, with a reverse mortgage, $ 100,000 equals the combined total of all principal and interest. On this particular loan, after 10 years and 3 months, the Smiths will owe $ 100,000. The breakdown is $ 61,500 in principle and $ 38,500 in interest. At that time, the loan will end. So the Smiths will only get $ 61,500, and they now owe the bank $ 100,000.
An ARM is a type of loan amortization where the most common feature is that the interest rate adjusts over the course of the loan. Thanks to the adjustable rate function, banks and lenders are better protected in the event that interest rates fluctuate wildly, as in the 1970s, when banks lent at a fixed rate of 8% and then rates reached 18%. %. This left the banks with loans that were losing money every month, as the banks had to pay money to depositors at rates higher than they were giving on their investments.
Important tip: ARM interest rates are usually lower than fixed rates. There are several types of ARM loans on the market today. All of this makes it easier for borrowers to qualify for a larger loan amount with an ARM. differ from each other in minor but important ways. There are four main criteria to consider when processing an ARM loan: the index used, the margin, the cap and the frequency of adjustment.
The interest rates on an ARM loan are based on an index, which is a published rate. The most commonly used indexes are:
COFI – The cost of funds index. This index is linked to the 11th District Federal Home Loan Bank Board in California. This index is also the most stable of all current indexes.
The Treasury Series – This is a series of maturity terms for Treasury bills. These bills are used as investments by the millions and are actively traded every day, so the rate changes daily.
LIBOR – The London Interbank Offered Rate is the rate the central bank of England uses to lend money to its banks.
Prime – This rate is the rate that US banks use to lend money to their best customers. This number is published daily in American newspapers, but it is important to know that each bank can set its own prime rate.
CD – This index comes from the rate paid for the purchase of 6 month certificates of deposit.
Margin is defined as the amount added to the index rate to determine the current rate charged on the ARM. Once you add the margin to the indexation rate, you get what is known as the Fully Indexed Rate (FIR). This rate is the actual rate that the borrower will pay. The interest rate quoted to a borrower at closing may be lower than the FIR.
The cap is a very important number because it is the maximum that a rate can change. So even if the index increases by 10% in a period, the FIR will not do so if the rate cap is reached. There are two types of caps to be concerned about when considering an MRA. The rate adjustment cap is the maximum that the rate can change from one period to another. And the Life of the Loan Cap is the maximum rate that can be charged during the loan. To understand how the rate will change, you need to know the index, margin, rate and cap. Add the index and the margin to determine the FIR. Then take the rate and add it to the cap. Whatever the smallest change, it will be the new interest rate.
SETTING THE FREQUENCY
This is how often the rate changes. Initially, when the loan is closed, the rate will be fixed for a while and then it will start to change. The frequency of change is the frequency of adjustment. So you can have a 7/1 arm, which means the rate will be fixed for 7 years and then adjust each year thereafter. Or you can have a 3/1 ARM. Fixed for 3 years. The more frequent the adjustment and the earlier it begins, the lower the initial interest rate. So a 3/1 ARM will have a lower rate than a 10/5. And that’s because the 10/5 has more risk for the lender. The 10/5 rate will be much closer to a fixed rate loan.
When a borrower is considering an ARM, it is usually because the rate is lower than the fixed rate loan. And so it is easier to qualify. But the borrower then bets against the bank. The ARM loan could prove to be more expensive than the long-term fixed rate loan if the rate increases during the life of the loan.
You need to have an idea of how long you are going to live in the house you are borrowing to buy. If you plan to stay there for the long term, a fixed rate may make more sense. MRAs are best for the military and others who buy and sell on a shorter time frame.
When a borrower considers an ARM, it is usually because the rate is lower then the fixed-rate loan. And thus it is easier to qualify for. But the borrower is then betting against the bank. The ARM loan might turn out to be more expensive than the fixed-rate loan in the long run if the rate rises during the term of the loan.
You must have an idea of how long you are going to live in the house you are borrowing to buy. If you are going to stay there long-term, a fixed-rate may make more sense. ARM’s are better for the military and other people who buy and sell within shorter time periods.
A conventional mortgage is a non-government loan financed with a value less than or equal to a specific amount established each year by the major secondary lenders. In 2008, funding of less than $ 417,000 was considered conventional funding. A conventional loan is the most popular loan today, which is why it has become the benchmark against all other mortgages. It has 4 particularities:
1. Set the monthly payments
2. Set the interest rates
3. Fixed loan term
A conventional loan is one that is guaranteed by government sponsored entities such as Fannie Mae and Freddie Mac. Since they are secured, the lender is assured that he can easily sell the loan in the secondary market.
And because of this insurance, these loans have the lowest rates.
In order to qualify as a conventional loan, home and borrowers must adhere to the guidelines set by the secondary lenders.
HOME ACTION LOANS
Real estate has traditionally been viewed as an illiquid asset. The property can only be converted to cash through sale or refinance. Both are very expensive and time consuming ways to raise money. Today’s borrowers can convert their home to cash immediately using the equity in their home.
These loans take much less time to approve and finance than regular home loans. And the fees are generally lower than for a normal loan. But home equity loans are usually placed in a second lien position after the original mortgage, at a higher interest rate. If the borrower does not pay, the house could be foreclosed.
The equity loan is an indefinite mortgage similar to a credit card. Borrowers can withdraw the money, use it, and repay the money whenever they want. Recently, home equity loans have led to new government regulations in some states as people get these loans without really understanding the consequences and therefore are being exploited by less than honest lenders.
A second mortgage is a loan on a second or “junior” property. In the event of foreclosure, the first creditor gets the first dibs on any money. In many cases, there isn’t enough equity in a home to pay off the first and second mortgage. So the second mortgagee can’t get anything. Therefore, being in second place can be a very risky place.
This is why secondary mortgages have higher rates than first mortgages. Second mortgages come in two main forms: a fixed mortgage and a home equity mortgage. The fixed mortgage follows the same format as a regular fixed loan. The equity mortgage is based on the equity in the home.
Loan officers use second mortgages to help the borrower avoid paying the PMI or to avoid a jumbo loan. A jumbo loan would be a non-conforming loan and therefore would have a higher rate for the entire loan. If a borrower wanted to avoid this, he could get a first mortgage at the maximum of conventional loans to be authorized, and a second for the balance. The rate on the second would be high but combined the rate would be lower than on the jumbo.
There are two government agencies that guarantee the loans: the Department of Veterans Affairs (VA) and the Federal Housing Administration (FHA).
VA loans are one of two types of government loans and are guaranteed by the Department of Veterans Affairs under the Military Readjustment Act. Lenders rely on this collateral to reduce their risk. The best thing about VA loans is that for veterans it allows them to enter a home with zero or very little down payment. The amount of down payment required depends on the entitlement and the loan amount. The requirements of military service vary. These loans are available to active-duty or separated veterans and their spouses.
These loans are self-amortizing if they are held for the entire term of the loan, but they can be repaid without penalty. These loans are only available through approved lenders. The amount of a veteran’s eligibility is stated in a certificate of eligibility that must be obtained from the VA office in your area.
Veterans who had a VA loan before may still have “remaining entitlement” to use for another VA loan. The current amount of duty was much lower previously and has been increased by changes in the law. For example, a veteran who obtained a loan of $ 25,000 in 1974 would have used a guarantee of $ 12,500, the maximum then available. Even if this loan is not repaid, the veteran could use the difference between the fee of $ 12,500 originally used and the current maximum to buy another home with VA financing.
Most lenders require that a combination of the right to collateral and any cash down payment be at least 25 percent of the reasonable value or sale price of the property, whichever is less. So, in the example, the veteran’s residual fee of $ 23,500 would meet a lender’s minimum collateral requirement for a no-down loan to purchase an appraised property selling for $ 94,000. The veteran could also combine a down payment with the remaining entitlement for a larger loan amount.
The Federal Housing Administration is one of the oldest and most important sources of mortgage assistance available to the general public. The Department of Housing and Urban Development (HUD) manages this program.
FHA-backed mortgages are the other type of government loan and are a consequence of public interest policy, with the idea that the government should stimulate the economy in general and the housing industry by particular. FHA loans like VA loans can only be obtained through approved lenders.
Why are FHA loans so popular? Because they have liberal qualifying standards, low or no down payments, and even closing costs can be funded and added to the loan. There is no prepayment penalty. FHA loans made before February 4, 1988 are freely assumable by a new buyer when the house is sold. Loans made after December 15, 1989 can only be assumed by qualified owner-occupiers and cannot be assumed by investors.
FHA loans also have limits. The recent housing appreciation has pushed the limits on this year’s loan program by nearly 16% in the continental United States.
If you would like to know the credit limit of your place of residence, you can call the consumer hotline of the Housing and Urban Development Department. Their toll-free number is available on their site. The FHA is a division of HUD.
As always, consult a mortgage advisor. A licensed mortgage planner will work with your own financial planner, real estate agent, CPA, and other advisors to find a mortgage product that’s right for you.
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