Mortgage Types
Mortgage types and interest rates have more variety than doughnuts. This is the challenging part of shopping for a mortgage.
We've done this several times. We've probably tried most of the common types of mortgages, from short-term 6-month mortgages (which normally offer the lowest interest rate, but which you have to negotiate the most frequently) to variable interest rate mortgages over a 5-year term.
Here's what we can say with good authority - your current mortgage rate may not be the best deal you could get. Unless you've gone to your lender with the same kind of steely determination with which you would face a used car salesman, you are likely paying more than you have to.
With this in mind, we'll also share what we've learned from the school of hard knocks.
So, pick the type of mortgage that you are interested in from the list below. There is a lot of information about each one!
Low Interest Rate Mortgage
A low interest rate mortgage is the fondest desire of every potential homebuyer.
How do you get a low interest rate mortgage? Well, while you can try to negotiate yourself with a commercial lender, you might also want to think about a mortgage broker.
A mortgage broker will do some of the footwork on your behalf. A mortgage broker may know about smaller lending institutions which are offering a much more competitive interest rate than a big bank or finance company. However, mortgage brokers will not necessarily work with all potential lenders. They are also not completely unbiased because they may prefer certain lenders who provide them with the best commission. So, you will always have to do some checking of your own. Having said that, a mortgage broker may find some great opportunities for you to get the lowest possible interest rate.
Once a mortgage broker identifies some good low interest rate mortgage opportunities it's up to you to be sure that the mortgage, and its options, match your needs.
Also, don't just take the broker's word for it that a company is a good one…check! You have to remember that the mortgage broker will be getting a commission if you take your mortgage with the company they recommend. Since they get a commission they are not completely 'unbiased'. For instance, they could recommend a company which gives them a better commission level. So, check before you say yes.
In the end, even if you use a broker, do some research yourself. You'll be more confident when you do sign on the dotted line. More importantly, you might even find a better low interest rate mortgage deal than the one you're being offered.
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Adjustable Rate Mortgage
Adjustable rate mortgages do what you'd expect - the rate 'adjusts'.
It works like this: With a fixed rate mortgage your monthly payments will be the same over the life of the mortgage. You'll always know what you'll have to pay. In contrast with an adjustable rate mortgage (sometimes called an ARM) your payments will change over time.
The mortgage payment will be 'adjusted' when the interest rate is adjusted. You can expect the interest rate to be adjusted at regular intervals.
Usually, you start with a period of a year at a fixed rate. This rate is often quite low, as an incentive to get an adjustable rate mortgage. Then, after the initial fixed period the interest rate is usually adjusted yearly to reflect the current rates. If the rates go down so do your mortgage payments. But if the rates go up, your payments will go up.
Here's an example: a "3/1 ARM" is fixed at an initial low rate for the first 3 years, and then adjusts every year based on an index. Common adjustable rate mortgages are: 1/1, 3/1, 5/1, 7/1, and 10/1. These adjustable rate mortgages stay fixed for 1, 3, 5, 7 or 10 years and then adjust every year.
In general, if you are interested in an adjustable rate mortgage take a relatively short fixed term - 3 years is likely the best; depending on the interest rate you are offered for the fixed term.
The benefit of ARMs is you have periods of fixed interest and then opportunities to take advantage of current interest rates. If rates go down, you benefit. The problem is that you may find your rate adjusting during periods of rising interest and this can mean higher payments and more money out of your pocket. But these do give you some of the benefits of variable rate mortgages with more stability for those who want to mitigate the risk of a variable rate mortgage.
However, as with all good deals check the fine print. Sometimes, an adjustable rate mortgage can cost you more in the long run, especially after the initial incentive interest rate is replaced by an adjusted rate. Know what you are getting into.
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Assumable Mortgage
You've put in an offer on a house. The real estate agent says that the seller of the property has a mortgage on the property that is 'assumable' and it's at a great interest rate. What do you do?
Assumable mortgages are mortgages that can be passed from one owner to another. It can be an advantage to assume a mortgage if the interest rate is very good compared to negotiating a brand new mortgage.
Keep in mind that you cannot assume a mortgage unless you have a big enough down payment to cover the difference between the value of the house and the amount of the mortgage. Otherwise, you are in the situation of negotiating a second mortgage - which you should generally avoid. Second mortgages are often at much higher interest rates and any savings you get from assuming the first mortgage could be lost.
Also remember that when you assume a mortgage you assume it 'as is'. This means that it may not have the options you want, like prepayment privileges and payment frequency options. Read the fine print on any mortgage contract - but especially if you want to assume a mortgage. Be sure it's the best deal for you.
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Straight Talk on Balloon Mortgages
There is a lot of talk lately about balloon mortgages. How is the consumer to separate the fact from the hype? The interest rates look good, but what's the catch? Let's start with some facts about balloon mortgages, in plain English. Then we'll discuss how they can be to your advantage.
Balloon mortgages are essentially a mortgage which must be paid in full at the end of the term. Over the course of the mortgage, you will pay a regular payment based on a typical amortization schedule. Then, as the mortgage term ends, the full amount comes due. The final payment you make is called the balloon payment. This payment is essentially the full balance of the mortgage loan.
So, why would you even consider this kind of mortgage? Isn't it a huge gamble? Not necessarily. Balloon mortgages can be an excellent choice if you are looking both for a lower interest rate and are likely to be in the home for a defined period. What if you decide to stay in the home you originally intended to sell? You can also refinance when the mortgage comes due.
Let's look at a scenario. If your company typically moves you from one workplace to another, at a regular and predictable schedule, then a balloon mortgage can work for you. You'll get the lower interest rate up front, and the trick is to time the end of your mortgage with the time in which you would typically sell your home! Then you can easily make your final balloon payment with the proceeds from your home, rather than have to refinance.
Balloon mortgages are generally available for similar time periods as other mortgages. You will likely be looking at a term of either 5 years or 7 years. As a result, these loans are frequently described in financial jargon as 5/25 or 7/23. However, don't count out balloon mortgages if you need a longer or shorter term. You can get terms as short as 3 years or as long as 10.
What's the difference between a balloon mortgage and your typical ARM (adjustable rate mortgage)? Typically, an ARM will adjust the interest rate on either a semi-annual or annual basis. If interest rates are going up, your rate will be going up regularly too. However, a balloon mortgage will normally only be subject to an interest rate adjustment once after the initial rate is set. Another plus of a balloon mortgage is those lower initial interest rates. Based on how the rates are calculated for balloon mortgages, you can sometime save as much as one or more percent.
However, there are disadvantages. With the typical ARM you can generally negotiate another mortgage with the same lender when the mortgage term is over without much difficulty. With a balloon mortgage, you could be making your refinancing process more challenging and costly. If interest rates on mortgages rise significantly, you could be setting yourself up for additional costs and potential problems. If rates rise more than 5 percent above the balloon interest rate, you could be required to re-qualify and have the home reappraised. This can cost you money and put the new mortgage in jeopardy if the appraised value is less than expected.
Having said that, it never hurts to comparison shop. Certainly, it's worth getting pricing on a balloon mortgage and an ARM mortgage at the same time. This gives you the opportunity to compare the options available to you and decide what is best in your situation.
So, you've decided to get a balloon mortgage? How do you do this? You will proceed exactly as you would for any other mortgage. You are still shopping for your best options and you should be asking a similar set of questions as you would ask for any mortgage:
"What's the interest rate?"
"When will the balance come due?"
"What kind of refinance options are available to me?"
"How can my refinance options be lost or forfeited and under what conditions?" (If a refinance option is included)
"Will I have to re-qualify for a mortgage when the balance comes due?"
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Interest Only Mortgage
An "interest-only" mortgage is like a line of credit. You can pay only the interest on the mortgage. This can greatly reduce your payments in time of financial stress. However, it also means that the debt will never be paid off.
With an interest only mortgage, you pay only interest for the first five, 10, even 15 years of the loan. This can lower your monthly payment by quite a lot. And that seems to have increased the popularity of interest only mortgages in the past few years.
The interest only mortgage is an interesting mortgage type. All you pay over the life of the mortgage is the interest on the balance. However, there are options once this interest only period ends. You either begin to pay interest and principal at a faster rate than if you’d done that from the beginning, or you can choose the balloon mortgage approach, which means the total loan principal becomes due at the end of your term.
When do interest only mortgages become more popular? Typically, as interest rates rise and the cost of housing increases, more people will look at this type of mortgage. Why? At issue for some consumers is the size of their mortgage payment and making that payment lower. At the same interest rate, an interest only payment is less than a payment of both interest and principal. A lower payment can mean that you will have a higher budget for home shopping. And that makes a big difference for some home buyers.
Many interest only mortgages have an interest only period (5 to 15 years) and then you begin to pay both interest and principal. If your interest only mortgage has a term of 30 years, after your initial interest free term, you would begin to pay interest and principal. You would begin to pay principal as well as interest in order to pay-off the balance by the end of 30 years. This actually means that your payments will be considerably higher than they would have been if you’d paid off principal all along.
Other interest only mortgages are like balloon mortgages. However, most balloon mortgages would ensure that you are paying down the original principal over time. When you pay your final balloon payment, it would be less than the original loan amount because of your payments of both interest and principal. With an interest only balloon mortgage, your final payment should be exactly equal to your original loan amount. All you’ve paid is interest; all the principal of the loan remains.
When would you consider this kind of loan? The circumstances to consider this kind of loan would be unique. Usually, a family with a single wage earner should not be considering this type of mortgage. Your exposure to financial risk would be too high. However, investors might be interested. The advantage with an investment property, that you expect to go up in value, is that the interest you pay is tax deductible. Therefore, you can deduct the interest paid from your taxes, while you own the property. At the end of the period of the loan, you could then sell your property (hopefully at a profit) and take the returns to pay out the mortgage.
However, this is a gamble. There’s no guarantee that the property appreciates in value. And there’s no guarantee that you can sell it when you decide to. If you can’t sell the property, you would have to refinance (unless you have made enough from the property to pay out the balance of your mortgage) and refinancing could cause you some challenges.
The other advantage to this kind of mortgage is that you can save or invest the money that you would have paid in principal on the loan. Again, this situation will usually favor investors of one kind or another.
Interest-only loans come with many of the options of other types of mortgages. With some, you can lock in a fixed interest rate for the full term, while others resemble adjustable rate mortgages (ARM), which carry a fixed rate for a certain number of years and then adjust every six months to a year.
What kind of savings are you looking at on your monthly mortgage payment? They can be significant. Let’s look at an example: You borrow $200,000 using an interest only loan with a 4.75 percent rate and no principal payments due for five years. Your monthly payment will be just $791, or about $250 a month less than if you went with a regular 5-year ARM with the same interest rate.
This can really work for you, if your property appreciates in value. Of course, there's never a guarantee that prices will go up. And if you don’t sell your property as planned, your monthly payment jumps drastically after your interest only period. You’ll have to be prepared for that.
Interest-only loans can also make sense for people whose income is sporadic, either because they are paid on commission or because they receive a significant portion of their income in annual bonuses. In this case, you have the option of only paying interest some months, but can pay above and beyond the amount due when they get their bonus checks. There is typically no prepayment penalty on interest only loans. This gives you flexibility in applying extra money to your mortgage when you have it, and yet keep monthly payments low.
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VA Mortgages
If you are among the 29 million veterans and service personnel who are eligible for a Veteran Loan, you may find that a VA loan gives you the resources needed to buy or refinance the home of your dreams, while ensuring you get the best rates. Veteran home loans can save you a great deal of money by giving you an excellent rate, with no monthly mortgage insurance (even with no down payment). Plus, it is easier to qualify for a VA (Veterans' Affairs) military loan as compared to a conventional mortgage. It's worth the time to look into!
If saving money on interest isn't enough, there are other benefits to a VA loan if you are a veteran:
- If you get a VA loan, there is zero down payment required when purchasing a home.
- With a VA loan, even if you have bad credit, you can get the same low interest rates for veteran home loans that are available to those with great credit, as long as you have been improving your credit history for the past year. Improving your credit history is as easy as making your current utility, rent, loan or credit payments on time. (Be sure that this change in your payment history is accurately reflected on your credit report.)
- Even with a Loan-to-Value of 100%, there is no monthly Mortgage Insurance required for a VA home loan. This alone can save you considerable money every month.
- The VA mortgage loan is guaranteed with no money down for any loan up to $359,650. All you have to do is qualify for the size of mortgage that fits within your budget.
- VA mortgage loans are often assumable. This means that you can transfer this mortgage to the new owner of the home when you sell. It can be a significant selling point, since VA loans have very competitive interest rates.
- VA has released a hybrid ARM product. Veterans now have a choice of a fixed rate or an Adjustable rate VA mortgage. So you have the choice of mortgage product that you want, even with a VA loan.
While VA loans are very attractive, there is a "Funding Fee". The Department of Veteran Affairs requires this fee, and it varies between 0 and 3.3 percent of the amount of the loan depending on your current Veteran Status. While the fee could be hundreds or thousands of dollars, depending on the size of your loan, it is generally added into the total loan amount, so you are not required to pay this out of pocket. This makes the fee manageable for most, and the lower interest rates frequently more than pay for the fee over time.
In some cases, this fee will be waived. Benefits for disabled veterans dictate that if you are 10% or more disabled due to active military service, you will not be required to pay a funding fee. So if you have been disabled during your military service, the VA loan will likely save you even more money.
Are you one of the individuals who will have to pay a funding fee? You can lower it by putting some money down on your VA home purchase. The more money you put down, the more your fee will be reduced.
So, how do you get a VA loan? You will need a certificate of eligibility to qualify. Whether you are a first time user of the VA loan system or you have used your eligibility in the past, you must have your certificate. If you don't have a certificate, you'll have to get one first. Contact your local Veteran Affairs office if you need to get a copy of yours.
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Fixed Rate Mortgage
A large majority of people choose the fixed rate mortgage. This mortgage guarantees a certain interest rate for a period of time. The most popular fixed mortgages are 3,4 and 5 years. However, you can have a fixed mortgage for as short as 6 months or as long as 10 years.
The biggest selling feature of fixed mortgages is the 'guarantee' of the payment that you will be paying. However, if you pick a long-term fixed mortgage - say 5 years - you'll pay a lot for the privilege of having your interest rate locked in. In general, unless interest rates are steadily climbing you'll pay more in interest costs over the life of your mortgage if you choose long term fixed each time.
Why? You'll actually pay a much higher interest rate over a longer period unless interest rates go up fairly significantly.
In my own case, I stayed with terms of 6 months on my fixed mortgage and found that I was averaging from 3/4 to 1 full percentage less in interest rates than those who had locked in at a five-year rate over the same time period. However, there are some caveats:
1. This strategy works best when interest rates are staying fairly stable (within 1 percentage point or so) or are falling.
2. You should have a mortgage lender who will allow you to lock in to a longer-term mortgage if rates go up and without a penalty.
If you have these two features through your lender go ahead and get a short-term fixed mortgage. The only downside is signing papers for your next term on a more frequent basis.
When looking at fixed rate mortgages don't be fooled by fancy promotions like cash back and other things. These incentives are usually restricted to 5 year and longer fixed rate mortgages. The lender can afford to give them because you are going to be their customer for a long time. Further, they don't reduce your interest rate which is the one thing that will really benefit you.
Your other best bet in an interest market where rates are staying the same or dropping is usually some form of 'variable' or 'adjustable' mortgage. These mortgages will allow you to get a better rate now in general (while the amount of your mortgage is higher) and will allow you to take advantage of fluctuating rates (which are hopefully moving in your favour). Again, you must have the option to lock in if rates go up. This will allow you to manage your risk. Simply keep a sharp eye on interest rates. Pay attention to what the analysts are saying about the short and longer-term future of rates. Then lock into a fixed rate mortgage from your variable or adjustable one.
This gives you the best of all possible worlds, including the lowest interest rate now and options later. But you have to make sure that you HAVE this option. Read the fine print. And be sure to ask your lender if it is possible before you sign the fixed rate mortgage papers.
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FHA Mortgages
The Federal Housing Administration (FHA) is a special program under the jurisdiction of the Department of Housing and Urban Development (HUD). FHA was established in the 1930's to improve housing standards and conditions, as well as provide an adequate home financing system through insurance of mortgages. In other words, FHA was the original mortgage insurance for US families! With the mortgage insurance provided through FHA, families that would otherwise be excluded from the housing market were finally able to buy homes.
How does an FHA mortgage work? FHA insures your lender against loss in the event that you default on your loan. Fundamentally, through this special insurance on the mortgage itself, FHA encourages lenders to make loans that they might otherwise view as too risky.
FHA began operations in the depths of the depression. At that time, many lenders had stopped making new loans altogether because of the large number that were in default. As the US worked its way out of the depression, the FHA began to focus more exclusively on helping low-and-moderate-income population become homeowners. In most cases, low- and moderate-income earners have challenges with buying a house either due to shaky credit or problems saving a down payment. For these people, turning to FHA mortgages allows them to buy their homes.
How do you qualify for FHA help? Well, first of all, you must be buying a home for your own occupancy. This program is not for you if you are looking to buy a property for rental. Secondly, you need to qualify in terms of income and credit. In most cases where you couldn't qualify for a conventional mortgage or the cost of that mortgage would be too high, but could afford a mortgage payment equivalent to your rental payment, FHA can provide you with some assistance.
Frankly, renting your home eats up your money and doesn't return equity into your hands. Owning your home does. This is where the FHA can give regular people a boost up, and into the housing market.
The FHA will insure both existing and newly built homes. In fact, insured loans can be used to finance the purchase of one to four family housing, which means that you can buy a property to live in with your extended family. Are you worried about your aging parents? You could look at a 2 family home and ensure that your parents are in good housing. You can also use FHA loans to refinance debt; so if you are looking to renegotiate a mortgage and you are having problems qualifying for a conventional mortgage at a good rate, you can also look to FHA. Just remember: the mortgage itself must be for your primary residence.
The FHA helps homeowners into the market in more than one way. With the FHA you can buy with as little as a 3 percent down payment. That can save you a lot of time spent saving up in order to get into the housing market. Most conventional mortgages require down payments of 10 percent or more of the purchase price of the home.
Another benefit of the FHA is that many closing costs can be financed. With most conventional loans, the borrower must pay closing costs (the many fees and charges associated with buying a home) equivalent to 2-3 percent of the price of the home. With an FHA loan, you can finance many of these closing costs, thus reducing the up-front cost to you of buying your home.
However, as good as the program is, FHA mortgage insurance is not free. You will pay an up-front insurance premium (which may be financed or rolled into your mortgage amount) at the time of purchase. In addition, you may have to pay monthly premiums that are not financed, but instead are added to the regular mortgage payment.
The FHA does protect you from some predatory lending practices. FHA rules impose limits on some of the fees that lenders may charge in making a loan. For example, the loan origination fee charged by the lender for the administrative cost of processing the loan may not exceed one percent of the amount of the mortgage.
While this program can be very useful, it is limited to certain people; you will have to qualify. To make sure that its programs serve low- and moderate-income people, FHA sets limits on the dollar value of the mortgage loan. These figures vary over time and by place, depending on the cost of living and other factors.
Any person able to meet the cash investment, the mortgage payments, and credit requirements can apply for an FHA mortgage. Applications are made through an FHA-approved lending institution. If you want more information before applying, be sure to check out the HUD website.
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HUD Mortgage Loans
The acronym HUD refers to Department of Housing and Urban Development. HUD is a department of the US federal government.
According to HUD's website, the mission of HUD is: "to increase homeownership, support community development and increase access to affordable housing free from discrimination. To fulfill this mission, HUD will embrace high standards of ethics, management and accountability and forge new partnerships--particularly with faith-based and community organizations--that leverage resources and improve HUD's ability to be effective on the community level."
That's a substantial mandate. As a result, HUD runs a wide variety of programs for consumers and for organizations, in order to foster affordable housing in the US. There are such a variety of programs that we'll only mention the most popular programs here. If you want more information, be sure to check the HUD website.
One of the biggest things that HUD does is help with buying a home. This is the primary reason most people come to HUD; they want to buy and they've run into problems, whether economics or discrimination. If you are having a problem with discrimination in home buying, you can lodge a complaint through HUD. If you are having an economic difficulty, including saving a down payment or being able to get good financing, HUD can help you directly.
Some home buying programs are designed to encourage people with certain jobs (like teacher and law enforcement officers) to move into neighbourhoods. The benefits to the home purchaser in these programs are substantial. You may be able to get up to 50% off of the price of a home in a designated revitalization area. However, you do have to qualify by proving you are a full-time member of the designated employment group. It's well worth the time to look into, if you are willing to move into a neighbourhood in these revitalization areas.
If you are currently a public housing resident, HUD wants to help you to own your own home instead of rent. This is part of the HUD mandate to foster home ownership. In some cases, existing rental buildings may be converted to condominium style housing, and you could be able to buy your current apartment. You can find out more about the programs and options for you through your local public housing authority or public housing agency.
HUD is also in the mortgage business. You can get lower cost mortgages and mortgage insurance through FHA, which is a program within the HUD mandate. Since you can use the FHA to get a mortgage, often with a very small down payment, it can be very helpful to families who could afford a mortgage, but are having a hard time saving for a down payment.
Some HUD programs vary at the state level. It's worthwhile to check with your local state government to find out if there are grants or other special HUD programs running in your state or your area.
Once you own your home, HUD can also help you to upgrade and renovate it! So not only will HUD help you to get a home, it will also help you to make that home more liveable for you. If your family includes seniors or people with disabilities, HUD may have money in the form of loans or grants that will help with necessary renovations.
Are you a renter who isn't ready to move? No problem. HUD can help you if you run into problems with your rental accommodation, due to cost or discrimination.
Not everything works out exactly as we might have intended. As a result, because HUD is also in the mortgage business for low and moderate income families through the FHA, it may also have foreclosed homes for sale. You can purchase these homes, and often at a good price.
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Source: mortgageguide101.com
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