Mortgage Types of Loans
If, 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 you. 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.
Fixed-rate mortgage loans — A fixed-rate mortgage ensures that your interest rate (and your payments) will stay the same for the life of your loan – which may be an important consideration if you plan to stay in your home for several years. When you choose the length of your repayment (usually 15, 20 or 30 years), keep in mind that while shorter term loans may have higher monthly payments, they also let you pay less interest and build equity faster.
30-year fixed-rate mortgage loan – The advantage of a 30-year fixed-rate mortgage loan is that it is the easiest to qualify for, and it 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 the maximum interest deduction for tax purposes.
20-year fixed-rate mortgage loan — The 20-year mortgage 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.
15-year fixed-rate mortgage loan — The advantage of a 15-year mortgage is that its interest rate is lower 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.
Adjustable-rate loans — 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. The types of people who typically benefit from an ARM are those that are planning to move or refinance in the near future, people with a high likelihood of increasing their income in later years, and people who need lower initial interest rates on their mortgage to be able to buy a home. 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 loan. The rates on an ARM usually change once or twice a year, and there is typically a lifetime rate cap (or limit) on both the amount of each individual rate adjustment and the total amount the rate can change over the whole term of the loan. For example, if your loan starts at 5 percent, has a 2 percent per-adjustment cap, and a lifetime adjustment cap of 4 percent, you know that your loan might go up to 7 percent the first time the rate changes. You also know that the rate can never go over 9 percent over the life of the loan (5 percent start plus 4 percent lifetime cap). 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.
CD-indexed ARMs (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. The standard form of these ARMs comes 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.
Treasury-indexed ARMs — These ARMs are indexed to the weekly average yield on 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 ARMs — 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 dates.
LIBOR-based ARMs – 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.
Initial fixed-period ARMs — 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 threes, fives, sevens, 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 your loan.
Two-step mortgage® — 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 US 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.
Government Loans — The Federal Housing Administration (FHA), the US 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:
- FHA loans
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.
- RHS Loans
The Rural Housing Service, a branch of the US 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 towns. Check with your local RHS office or a local lender for eligibility requirements. For the location of RHS State Offices and details on RHS loans, see the RHS home page.
- State 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. (Check with your state housing authority. The phone numbers usually can be found in the government “blue pages” of the phone book.)
- Balloon loans — These short-term loans (usually 5, 7 or 10 years) offer lower interest rates, but only a piece of what you borrow is paid off during the term of the loan. At the end of the term, you pay off the remaining balance in a lump sum or refinance it. If you think you will be selling or refinancing your home in 5 to 7 years, you may benefit from obtaining a balloon mortgage. The interest rate on a balloon mortgage is lower than that of a fully amortizing fixed-rate mortgage. You begin paying under a balloon mortgage an initial rate, 7 percent for example. You would continue paying that 7 percent rate for the first 5, 7 or 10 years, based on the term of your loan. At the end of your 5, 7 or 10-year term, all of your outstanding loan balance would be due.
Some lenders will permit you to extend your loan beyond the balloon date if you pay a fee and refinance your loan based on the then current interest rate. It is important to find out before you enter into a balloon mortgage whether your lender will allow you to refinance. Not all lenders will promise to extend your loan beyond the balloon date. This type of loan should not be pursued if you have concerns about meeting the refinance conditions or think the balloon term will be due before you are ready to move or refinance.
Affordable housing loans — 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.
Fannie Mae’s Community Home Buyer’s Program® — Fannie Mae’s Community Home Buyer’s 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. Your local lender or Fannie Mae® can advise you of the median income in your area.
The Community Home Buyer’s Program builds flexibility into the lender’s 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.
3/2 Option® — An important feature of the Community Home Buyer’s 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.
Fannie 97® — 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 government agencies.
FannieNeighbors® – 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. Click here for a list of designated eligible cities. A central city is defined by the US 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.
Home improvement loans — If you’re looking to buy and renovate – or refinance and renovate – a home, look into Fannie Mae’s HomeStyle® mortgages. With a HomeStyle mortgage, you can buy or refinance a home and pay for home improvements all with one loan.
HomeStyle® mortgages – Today, more people are purchasing older homes in need of repair and renovation or are choosing to improve or enlarge their current homes. As a result, there is an increasing need for mortgages that combine the cost of purchase and renovation. Fannie Mae’s HomeStyle® mortgages allow you to do just that. With Fannie Mae’s HomeStyle® mortgages, you can finance your new home and renovation at the same time and with one loan. This loan is based on the amount that the house will be worth after the renovation is completed. These loans require two appraisals: an appraisal of the current market value of your home and a second appraisal of the value of your home after the renovations will be complete.
With the HomeStyle Standard Mortgage®, home buyers can complete improvements or repairs at low mortgage interest rates. With the HomeStyle Community Mortgage®, low- and moderate-income borrowers can purchase and improve their home with as little as 3 percent down, and use a gift, a grant, or a government or nonprofit loan to pay the remaining 2 percent of the down payment. This feature is called the 3/2 Option®.
Do you plan to purchase and improve a home but not use the property as a primary residence? If so, the HomeStyle Investor Mortgage® allows you to do just that. You are eligible for the same low rates and this mortgage can be used for purchase of a one- to four-unit property. For information on home improvement lenders near you, see the state-by-state directory at www.homepath.com.