Different types of loans including an explanation of Fixed-Rate loans, Adjustable-Rate loans, Convertible Mortgage Loans, and Balloon Mortgage Loans.
Major types of mortgage loans include:
Fixed-rate fully amortizing loans are the most popular type of mortgage loan, as they offer a monthly payment that does not change over time, and result in a portion of the loan’s principal being paid down every month. Many borrowers find fixed-rate home loans to be the best mortgage for their needs. Nearly all mortgage lenders including mortgage bankers and mortgage brokers, offer fixed-rate mortgages in all of their Conventional, FHA, VA and Jumbo loan products.
Most fixed-rate mortgages are for loan terms of 15 or 30-years. A 30-year amortizing loan typically has lower payments than a 15-year loan, but a slightly higher interest rate than a 15-year loan. To pay off a fixed-rate loan sooner, check with your servicing lender to ensure these extra principal payments are accounted for in the correct manner so they get recorded correctly to your account. Most monthly mortgage statements have a box for you to enter the amount of extra principal you are making. In most circumstances, you should be permitted to make these additional principal payments anytime and for any amount, and without penalty.
An adjustable-rate mortgage has a short-term fixed-rate term during which an interest rate is fixed. After this initial term, the interest rate on an adjustable-rate mortgage or “ARM” loan can change periodically at certain intervals. This adjustment permits the lender to adjust the interest rate to match changing interest rate environments. For example, a 3/1 ARM loan offers a fixed-rate for the first three years, adjusting once a year thereafter. A 5/1 ARM loan offers a fixed-rate for the first five years, adjusting yearly thereafter.
At each adjustment the lender sets the interest rate by adding a margin or spread to the then current index rate.
Common indexes used in adjustable-rate loans include:
The 11th District Cost of Funds Index: The Eleventh District of the Federal Home Loan Bank Board, which covers California, Nevada and Arizona, publishes a Cost of Funds Index. For more information on the index, visit the Web site of the Federal Home Loan Bank of San Francisco.
The Treasury Bill Index: The yield on the 1-year T-bill, adjusted for a constant-maturity security, is widely used. Most ARM loans have a periodic rate cap and lifetime cap to limit the amount the interest rate can increase each adjustment period and over the term of the loan, respectively.
Libor-based indexes: Libor, or the London Interbank Offered Rate index, is frequently used by lenders as many international investors in Mortgage-Backed Securities prefer this index. There are 1- month, 6- month, and 1- year Libor indexes used in many Conventional, FHA, VA and Jumbo loans.
What is negative amortization? While many adjustable-rate loans have periodic caps that limit the extent to which an interest rate can rise or fall during an given period of time, some adjustable-rate loans have a payment cap which limits how high the actual mortgage payment can rise in dollars, as opposed to limiting interest rate changes. Unfortunately, in many cases, while the actual mortgage payment in dollars may seem attractive to your monthly budget, that “capped” mortgage payment may not cover the actual interest owed during a given payment period, and you may face negative amortization of your loan. Negative amortization has the effect of increasing the amount you owe on your loan every month, as opposed to paying down your loan every month, with a normal fully amortizing loan.