Fortunately for buyers, there are a variety of mortgages to choose from. It is in your best interest to investigate each of them to determine which is the best for your situation. You probably won't qualify for all of them. In fact, you may only qualify for one. But if you do qualify for more than one, you may save yourself money (and worries) in the long run if you do your homework before signing on the dotted line. The more common ones are split between four categories Fixed Rate Mortgages, Adjustable or (ARM) Mortgages, FHA/VA Mortgages and Balloon Mortgages.
The most common type of mortgage program where your monthly payments for interest and principal never change. Property taxes and homeowners insurance may increase, but generally your monthly payments will be very stable.
Fixed rate mortgages are available for 30 years, 20 years, 15 years and even 10 years. There are also "biweekly" mortgages, which shorten the loan by calling for half the monthly payment every two weeks. (Since there are 52 weeks in a year, you make 26 payments, or 13 "months" worth, every year.)
Fixed rate fully amortizing loans have two distinct features. First, the interest rate remains fixed for the life of the loan. Secondly, the payments remain level for the life of the loan and are structured to repay the loan at the end of the loan term. The most common fixed rate loans are 15 year and 30 year mortgages.
During the early amortization period, a large percentage of the monthly payment is used for paying the interest . As the loan is paid down, more of the monthly payment is applied to principal . A typical 30 year fixed rate mortgage takes 22.5 years of level payments to pay half of the original loan amount.
Adjustable rate mortgages do just that: adjust their rate. Simply put, a loan that starts with an initial rate of 5% may be 7% the next year and 9% the 3rd year. Does my payment change? In most cases, YES. When interest rates change, payments are re-calculated on the remaining principal balance for the remaining term at the new interest rate.
Rates charged during the initial period are generally lower than those on comparable fixed-rate mortgages. After all, lenders have to offer something to make it worthwhile to assume the risk of higher rates in the future.
The initial fixed-rate period can be as short as a month and as long as 10 years. One-year ARMs, which have their first adjustment after one year, used to be the most popular and were the benchmark. Recently the standard has become the 5/1 ARM, which has an initial fixed-rate period that lasts five years; the rate is adjusted annually thereafter. That type of mortgage, which mixes a lengthy fixed period with an even lengthier adjustable period, is known as a hybrid. Other popular hybrid ARMs are the 3/1, the 7/1 and the 10/1.
After the fixed-rate honeymoon, an ARM's rate fluctuates at the same rate as an index spelled out in closing documents. The lender finds out what the index value is, adds a margin to that figure and recalculates the borrower's new rate and payment. The process repeats each time an adjustment date rolls around.
FHA / VA Loans
If you are a first time homebuyer or have low to moderate income, you may be eligible for a mortgage insured by the Department of Housing and Urban Development (HUD) through the Federal Housing Administration (FHA). FHA's mortgage insurance programs help low and moderate income families become homeowners by lowering some of the costs of their mortgage loans. While this insurance is not free, you can finance the up front insurance premium at the time of purchase and add to your regular mortgage payments.
You may be able to get an FHA loan with a low down payment of only 3% of the loan amount or less. FHA also allows 100% of this down payment to be a gift from friends, family or other sources. Many closing costs can also be financed to reduce the up front cost of buying a home.
FHA has maximum loan amounts, which vary from one county to another. It is critical that your loan amount, including financed closing costs, not exceed the maximum set by FHA for the county in which your property is located. There are no income limits on FHA loans.
FHA has several loan programs that include:
Section 203(b) - A single family program that has down payment requirements as low as 3%, allowing you to finance up to 97% of the value of the home.
Streamline refinance - A program that reduces the amount of documentation and underwriting that needs to be performed by the mortgage company.
Section 203(k) - A single family home rehabilitation program that enables you to finance both the purchase or refinance of a house and/or the cost of its rehabilitation through a single mortgage.
Section 203(i) – A single family mortgage program that provides mortgage insurance for a person to purchase a principal residence in a rural area.
FHA ARM - A single family adjustable rate mortgage that provide mortgage insurance for a person to purchase or refinance a principal residence at a lower initial interest rate.
Property Improvement Loan Insurance (Title I) – A program that makes it easier for consumers to obtain affordable home improvement loans by insuring loans made by private lenders to improve properties that meet certain requirements.
Energy Efficient Mortgage – A program that provides mortgage insurance for the purchase or refinance of a principal residence that incorporates the cost of energy efficient improvements into the loan.
Reverse Mortgage – A program for homeowners 62 and older who have paid off their mortgages or have only small mortgage balances remaining. The program allows homeowners to borrow against the equity in their homes in a lump sum, on a monthly basis for a fixed term or for as long as they live in the home, or on an occasional basis as a line of credit.
If you have ever paid off a home loan backed by FHA, you may have money owed to you. FHA may have an escrow refund waiting for you.
Balloon loans are short term mortgages that have some features of a fixed rate mortgage. The loans provide a level payment feature during the term of the loan, but as opposed to the 30 year fixed rate mortgage, balloon loans do not fully amortize over the original term. Balloon loans can have many types of maturities, but most balloons that are first mortgages have a term of 5 to 7 years.
At the end of the loan term there is still a remaining principal loan balance and the mortgage company generally requires that the loan be paid in full, which can be accomplished by refinancing. Many companies have other options such as a conversion feature at the end of the term. For example, the loan may convert to a 30 year fixed loan at the thirty year market rate plus 3/8 of a percentage point. Your conversion can be guaranteed based on certain criteria such as having made your last 24 payments on time. The balloon mortgage program with the conversion option is often called a 7/23 Convertible or 5/25 Convertible.