There isn’t a single or simple answer to this question. The right type of mortgage for you depends on many different factors:
For example, a 15-year fixed rate mortgage can save you many thousands of dollars in interest payments over the life of the loan, but your monthly payments will be higher. An adjustable rate mortgage may get you started with a lower monthly payment than a fixed rate mortgage, but your payments could get higher when the interest rate changes.
The best way to find the “right” answer is to discuss your finances, your plans and financial prospects, and your preferences frankly with a mortgage professional.
Conventional loans are secured by government sponsored entities or GSEs such as Fannie Mae and Freddie Mac. Conventional loans can be made to purchase or refinance homes with first and second mortgages on single family to four family homes.
In general, Fannie Mae and Freddie Mac’s single family, first mortgage loan limit is $417,000 in 2006. This limit is reviewed annually and, if needed, changed to reflect changes in the national average price for single family homes. The current loan limit applies to all conventional mortgages delivered after January 1, 2006.
Conventional Loan Limits
Note: Maximum original loan amounts are 50 percent higher for first mortgages on properties in Alaska, Hawaii, Guam and the U.S. Virgin Islands.
Loans which are larger than the limits set by Fannie Mae and Freddie Mac are called jumbo loans. Because jumbo loans are not funded by these government sponsored entities, they usually carry a higher interest rate and some additional underwriting requirements. A strategy to lower your overall interest payments if your purchase or refinance balance is above $417,000 is to use a combination of both first and second trust money, referred to as an 80/10/10, 80/15/5 or 80/20. Every situation is different, but it is one more option to consider.
In addition to common loan structures such as fixed rate, adjustable rate and balloon loans, Fannie Mae and Freddie Mac also have loan programs for low to no down payments, community lending and affordable housing initiatives, construction to permanent, home improvement and reverse mortgages.
If you have bad credit, you may not qualify for a conventional loan or a low down payment loan offered by FHA and VA. In this case, you may consider a subprime mortgage. Because of the higher risk associated with lending to borrowers that have a poor credit history, subprime loans typically require a larger down payment and a higher interest rate.
You should study the specific terms of a subprime loan that you qualify for to determine if it is a loan that will help your financial situation. Subprime loans are one way for you to get into the home you want at today’s price. If you already own a home, a subprime loan can give you an opportunity to clean up your credit and ultimately refinance into a lower rate at a later time. If you have a mortgage, you can look at refinancing more than what you currently owe on the house and get cash back for the equity you already have in the home. This cash out could be used to pay off higher rate credit cards, bankruptcy, foreclosure or collections and liens. It could be a good way to clean up a troubled credit history, save money each month and start rebuilding your credit worthiness.
Whether for a purchase or refinance, subprime loans should typically be used as a short term solution, approximately 2-4 years. During that time, you can work to clean up your credit and qualify or a refinance into a lower risk, lower rate loan.
Prior to 1990 it was very difficult for anyone to obtain a mortgage if they did not qualify for a conventional, FHA or VA loan. Subprime loans were developed to help higher risk borrowers obtain a mortgage. Many borrowers with bad credit are good people who honestly intended to pay their bills on time. Catastrophic events such as the loss of a job or a family illness can lead to missed or late payments or even foreclosure and bankruptcy. Now there are mortgage companies that take into consideration events outside the borrower’s control, but not without a price.
Lenders are compensated for risk in the form of interest rates. The higher the lender perceived its risk to be, the higher the rate they will charge for the privilege of borrowing their money. The lower the risk, the lower the rate. Several risk factors are taken into consideration when evaluating a borrower for a subprime mortgage, the most important being your payment and credit history.
Your debt to income level, employment history, type of property and assets are other factors that are taken into consideration when determining if you qualify for a conventional, government or subprime loan.
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.
These loans generally begin with an interest rate that is 2-3 percent below a comparable fixed rate mortgage, and could allow you to buy a more expensive home.
However, the interest rate changes at specified intervals (for example, every year) depending on changing market conditions; if interest rates go up, your monthly mortgage payment will go up, too. However, if rates go down, your mortgage payment will drop also.
There are also mortgages that combine aspects of fixed and adjustable rate mortgages – starting at a low fixed rate for seven to ten years, for example, then adjusting to market conditions. Ask your mortgage professional about these and other special kinds of mortgages that fit your specific financial situation. More information on ARM Loans Here.
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.
“Interest only” products are an easy way to save money and a very popular alternative to traditional fixed rates but they are not without risk. An “Interest Only” loan can offer consumers greater purchasing power, increased cash flow and a number of other benefits which are listed later in this article.
First let us start with a quick explanation of how the product works. With Interest only loans the borrower has the flexibility of paying only the interest due on the mortgage. Most of these products allow you to pay extra if you choose.
The positive aspects of these loans are as follows:
They work well for borrowers that are restricted by a tight budget, and the savings can be as much as $300-400 per month!
Interest Only loan can allow you to qualify for a bigger home. If the underwriter considers only the “Interest Only” payment, you may be able to upgrade to a nicer or larger home.
This type of loan works well for people who only want to stay in a home for a just a few years. During the first couple of years with a conventional 30 yr mortgage, most of your mortgage payment is being applied directly to the interest of the loan. If you want to stay in the house for only 3-5 years, an “Interest Only” loan may be the right loan for you. You can receive a lower payment and have almost the same principal balance as the borrower who chose a 30 year, conventional mortgage if you choose to sell in 3-5 years.
You want to buy a very expensive home. Most people who buy very expensive home have no desire to pay off their home completely, and the rate of appreciation on the house is usually very good. An “Interest Only” loan allows these borrowers to deduct their interest payments, and the money they save can be directed to other investments.
You want to buy a rental property. The lower payment can help improve cash flow on a rental property.
As with every loan program, with positives there are always negatives.
You are not paying down your principal on your mortgage. If your property doesn’t appreciate in value over those 3-5 years, you may even have to pay money if you choose to sell the home. While the likelihood of this happening is high, it is a risk that must be considered when thinking about using Interest Only loans.
Most “Interest Only” products have a specified term. For example, on most 30 year fixed “Interest Only” loans, most lenders allow interest payments for 10 years, and then you must repay the loan during the last 20 years. This loan now must be amortized over a 20 year period, and this will carry a higher payment than a 30 year fixed mortgage. These loans may be a good option for you as a borrower, but each person’s situation is unique.
Lastly, when in a period of incredibly low fixed rates “Interest Only” products will be very attractive. But, if you are planning on staying in your home for an extended period of time, you may want to consider a traditional fixed product.
The GPM is another alternative to the conventional adjustable rate mortgage, and is making a comeback as borrowers and mortgage companies seek alternatives to assist in qualify for home financing.
Unlike an ARM, GPMs have a fixed note rate and payment schedule. With a GPM the payments are usually fixed for one year at a time. Each year for five years the payments graduate at 7.5% – 12.5% of the previous years payment.
GPMs are available in 30 year and 15 year amortization, and for both conforming and jumbo loans. With the graduated payments and a fixed note rate, GPMs have scheduled negative amortization of approximately 10% – 12% of the loan amount depending on the note rate. The higher the note rate the larger degree of negative amortization. This compares to the possible negative amortization of a monthly adjusting ARM of 10% of the loan amount. Both loans give the consumer the ability to pay the additional principal and avoid the negative amortization. In contrast, the GPM has a fixed payment schedule so the additional principal payments reduce the term of the loan. The ARMs additional payments avoid the negative amortization and the payments decrease while the term of the loan remains constant.
The scheduled negative amortization on a GPM differs depending on the amortization schedule, the note rate and the payment increases of the loan. GPM loans with 7.5% annual payment increases offer the lowest qualifying rate but the largest amount of negative amortization.
On a loan of $150,000, with a 30 year amortization and a note rate of 10.50% with 12.5% annual payment increases, the negative amortization continues for 60 months. The qualifying rate is 5.75% and the negative amortization is 11.34% (approximately $17,010).
The note rate of a GPM is traditionally .5% to .75% higher than the note rate of a straight fixed rate mortgage. The higher note rate and scheduled negative amortization of the GPM makes the cost of the mortgage more expensive to the borrower in the long run. In addition, the borrowers monthly payment can increase by as much as 50% by the final payment adjustment.
The lower qualifying rate of the GPM can help borrowers maximize their purchasing power, and can be useful in a market with rapid appreciation. In markets where appreciation is moderate, and a borrower needs to move during the scheduled negative amortization period they could create an unpleasant situation.
The most common buy down is the 2-1 buy down. In the past, for a buyer to secure a 2-1 buy down they would pay 3 points above current market points in order to pay a below market interest rate during the first two years of the loan. At the end of the two years they would then pay the old market rate for the remaining term.
As an example, if the current market rate for a conforming fixed rate loan is 8.5% at a cost of 1.5 points, the buy down gives the borrower a first year rate of 6.50%, a second year rate of 7.50% and a third through 30th year rate of 8.50% and the cost would be 4.5 points. Buy downs were usually paid for by a transferring company because of the high points associated with them.
In today’s market, mortgage companies have designed variations of the old buy downs rather than charge higher points to the buyer in the beginning they increase the note rate to cover their yields in the later years.
As an example, if the current rate for a conforming fixed rate loan is 8.50% at a cost of 1.5 points, the buy down would give the buyer a first year rate of 7.25%, a second year rate of 8.25% and a third through 30th year rate of 9.25%, or a three quarter point higher note rate than the current market and the cost would remain at 1.5 points.
Another common buy down is the 3-2-1 buy down which works much in the same ways as the 2-1 buy down, with the exception of the starting interest rate being 3% below the note rate. Another variation is the flex fixed buy down program that increase at six month interval rather than annual intervals.
As an example, for a flex fixed jumbo buy down at a cost of 1.5 points, the first six months rate would be 7.50%, the second six months the rate would be 8.00%, the next six months rate would be 8.50%, the next six months rate would be 9.00%, the next six months the rate would be 9.50% and at the 37th month the rate would reach the note rate of 9.875% and would remain there for the remainder of the term. A comparable jumbo 30 year fixed at 1.5 points would be 8.875%.
A reverse mortgage is a special type of loan made to older homeowners to enable them to convert the equity in their home to cash to finance living expenses, home improvements, in home health care, or other needs.
With a reverse mortgage, the payment stream is “reversed.” That is, payments are made by the lender to the borrower, rather than monthly repayments by the borrower to the lender, as occurs with a regular home purchase mortgage.
A reverse mortgage is a sophisticated financial planning tool that enables seniors to stay in their home or “age in place” and maintain or improve their standard of living without taking on a monthly mortgage payment. The process of obtaining a reverse mortgage involves a number of different steps.
The first most widely available reverse mortgage in the United States was the federally insured Home Equity Conversion Mortgage (HECM), which was authorized in 1987.
A reverse mortgage is different from a home equity loan or line of credit, which many banks and thrifts offer. With a home equity loan or line of credit, an applicant must meet certain income and credit requirements, begin monthly repayments immediately, and the home can have an existing first mortgage on it. In addition, there is no restriction on the age of borrowers.
In general, reverse mortgages are limited to borrowers 62 years or older who own their home free and clear of debt or nearly so, and the home is free of tax liens.
Borrowers usually have a choice of receiving the proceeds from a reverse mortgage in the form of a lump sum payment, fixed monthly payments for life, or line of credit. Some types of reverse mortgages also allow fixed monthly payments for a finite time period, or a combination of monthly payments and line of credit. The interest rate charged on a reverse mortgage is usually an adjustable rate that changes monthly or yearly. However, the size of monthly payments received by the senior doesn’t change.
Some reverse mortgage products also involve the purchase of an annuity that can assure continued monthly income to the senior homeowner even after they sell the home.
The size of reverse mortgage that a senior homeowner can receive depends on the type of reverse mortgage, the borrower’s age and current interest rates, and the home’s property value. The older the applicant is, the larger the monthly payments or line of credit. This is because of the use of projected life expectancies in determining the size of reverse mortgages.
Seniors do not have to meet income or credit requirements to qualify for a reverse mortgage.
Unlike a home purchase mortgage or home equity loan, a reverse mortgage doesn’t require monthly repayments by the borrower to the lender. A reverse mortgage isn’t repayable until the borrower no longer occupies the home as his or her principal residence.
This can occur if the sole remaining borrower dies, the borrower sells the home, or the borrower moves out of the home, say, to a nursing home.
The repayment obligation for a reverse mortgage is equal to the principal balance of the loan, plus accrued interest, plus any finance charges paid for through the mortgage. This repayment obligation, however, can’t exceed the value of the home.
The loan may be repaid by the borrower or by the borrower’s family or estate, with or without a sale of the home. If the home is sold and the sale proceeds exceed the repayment obligation, the excess funds go to the borrower or borrower’s estate. If the sales proceeds are less than the amount owed, the shortfall is usually covered by insurance or some other party and is not the responsibility of the borrower or borrower’s estate. In general, the repayment obligation of the borrower or borrower’s estate can’t exceed the value of the property.
In general, a borrower can’t be forced to sell their home to repay a reverse mortgage as long as they occupy the home, even if the total of the monthly payments to the borrower exceeds the value of the home.