What type of loan program are best?
The subjects below explain the main loan categories that
the many loan programs fall under. These are major
types of loans, not to be confused with the individual
loan programs themselves (such as Fixed Rate Loans or Adjustable
Rate Mortgages).
CONVENTIONAL LOANS:
Conventional loans are loans that are not insured or guaranteed
by a government agency (see FHA and VA for information
on government loans). They can be conforming or
non-conforming loans. Most of the conventional
loans that have been made in the last several years have
three basic attributes in common: 1) They have been for
long terms, 2) They have been loans with fixed interest
rates, and 3) they have been fully amortized (see Fixed
Rate Loans and Adjustable Rate Loans.
CONFORMING LOANS:
Conforming loans can be resold in the secondary market
due to the fact that they meet nationally accepted underwriting
criteria established by national secondary market investors,
primarily Fannie Mae (FNMA) and Freddie Mac (FHLMC). This
criteria includes down payment amounts, maximum loan
amounts, property specifications, borrower income requirements
and credit guidelines. Due to the importance of
being able to liquidate real estate investments (loans)
in the event of a financial problem, the trend for lenders
is to obtain loans that meet secondary market standards.
NON-CONFORMING LOANS:
Non-conforming loans are loans that do not conform to the
guidelines set forth by Fannie Mae or Freddie Mac. Non-conforming
loans consist of Jumbo loans (exceeding the conforming
loan limit), inadequate credit history or derogatory
credit, not enough income, home equity or home improvement
loans, credit lines, and second mortgages to name a few.
GOVERNMENT LOANS:
Government loans consist of loans that are in some way
guaranteed or purchased by government owned corporations
or organizations. For instance, GNMA (Government
National Mortgage Association) assists in the financing
of urban renewal and housing projects by providing below-market
rates to low income families. GNMA guarantees the
payment of principal and interest on FHA and VA mortgages
through its mortgage-backed securities program. It
operates under the Department of Housing and Urban Development
(HUD).
IN-HOUSE or PORTFOLIO LOANS:
Portfolio loans are loans that banks or other lending institutions
may keep "in-house", or sell to the secondary
market (FNMA or FHLMC). The qualifying guidelines
for these types of loans may be more flexible than the
requirements set forth by secondary market investors.
COMMERCIAL LOANS:
Commercial loans are generally made by commercial banks
who normally supply capital for business ventures and construction
activities on a comparatively short-term basis. Although
in recent years, large commercial banks have increased
their participation in home mortgage lending. They
usually make loans on residential properties with five
or more units (apartment complexes), warehouses, office
buildings, etc.
What advantages does a Fixed-rate loan have?
A long-term, fixed-rate real estate loan is repaid over
a 15, 20 or 30 year term at an unchanging monthly payment
and interest rate. A long-term fully amortized loan has
distinct advantages for the borrower. The equal payments
are spread out over a long period of time keeping the payments
manageable and there is no balloon payment required at
the end of the loan term. This type of loan is the
most popular with borrowers mostly because this is the
type of loan program that they are most familiar with.
What are the advantages of a 15-year
fixed-rate loan?
The 15-year, fixed-rate loan is becoming increasingly more
popular every year. They often have a lower interest
rate, ownership in half the time of a 30-year fixed loan,
and fantastic savings over the life of the loan.
What are the disadvantages of a 15-year fixed-rate
loan?
The two major disadvantages of a 15-year fixed-rate loan
are larger monthly payments, and smaller tax deductions.
The advantages and disadvantages of a 30-year fixed-rate
loan are the opposite of the explanations for a 15-year
fixed-rate loan.
Which is the most comon?
Generally, a 15 or 30-year fixed-rate fully amortized
loan is what most homeowners shoot for until the rates
rise to around 8%-9%. At this point the advantages
dim in the light of other popular programs such as 2 to
1 buydowns, and Adjustable Rate Mortgages (Arm's).
What's an Adjustable-rate Mortgage?
Possibly one of the most popular, yet misunderstood forms
of alternate financing is the adjustable-rate mortgage. Usually
referred to as an ARM, its popularity with borrowers is due to a lower interest
rate than a fixed-rate loan.
It is popular with the lenders because the ARM shifts
the risk of interest rate fluctuations to the borrower.
Although borrowers would rather have the security of a
fixed-rate loan provided the rate is not too high, the
ARM has maintained its popularity in the market despite
competitively priced mortgage loan rates.
An ARM is a loan that allows the lender to adjust the
interest rate so it reflects fluctuations in the cost of
money more accurately. However, with an ARM, the
borrower is the one who is affected by interest rate movements,
not the lender. If interest rates rise, the borrowers
payments also go up - if the rates fall, the borrowers
monthly payments will drop along with the declining rates.
How does an ARM work?
The borrower's interest rate is determined by the cost
of money at the time the loan is made. Then the rate
is tied to a recognized index your lender is currently
using for this loan. Your future interest adjustments
are then based on the upward or downward movements of this
index. An index is a reliable statistical report
that reflects the approximate change in the cost of money. Some
examples of this would be the monthly average yield on
three year treasury securities, or the national average
mortgage contract rate for purchases on previously occupied
homes. The rise and fall of your payments will fluctuate
with the index preferred by the lender for this loan program
when your loan was made.
To insure that the expenses of administration and profit
are included in the payments to the lender, it is necessary
for the lender to add a margin to the index. Different
lenders use different margins which explains the variation
in interest rates offered for the same loan program. Margins
range from 2% to 4% and are added to the index to come
up with the interest rate you pay (margin + index = interest
rate). It's the fluctuation of the index rate that
causes the borrowers interest rate to increase or decrease.
What are the elements of an ARM?
INDEX:
Lenders generally use an index that will be responsive to fluctuations in our
economy - usually a one-year Treasury security or the cost-of-funds index (COFI). The
cost-of-funds index is more stable than the Treasury index because it doesn't
rise or fall as sharply over the long term as the Treasury index, Libor, MTA
& Prime or other indexes commonly used by lenders.
MARGIN:
The margin is the difference between the index
rate and the interest charged to the borrower. The
margin doesn't change throughout the loan term.
RATE ADJUSTMENT PERIOD
The borrowers interest rates on
an adjustable-rate mortgage are allowed to be adjusted
at certain intervals during the loan term. Depending
on the type of adjustable loan you have, this interval
could be six months, one year, three years or more.
INTEREST RATE CAP:
There are limits on just how much your
payments can go up if you have an ARM. Usually these
caps are in the form of interest rate caps and/or payment
caps. An
interest rate cap determines the maximum number of percentage
points your interest can increase over the life of the
loan.
MORTGAGE PAYMENT ADJUSTMENT PERIOD:
The mortgage payment
adjustment period is the agreed upon intervals at which
the payments of principal and interest are changed. The lender can either adjust the rate
periodically and adjust the mortgage payment to reflect
the change, or the lender can adjust the rate more frequently
than the mortgage payment is adjusted. For example,
the loan agreement may call for the interest to be adjusted
every six months, but the payment to be adjusted every
three years. This scenario could be a problem. If
in the interim between payment periods (3 years), interest
rates have gone up or down too much, there will have been
too much or too little interest paid on the loan by the
borrower over that period of time, and the difference will
be added to or subtracted from the loan balance. When
unpaid interest is added to the loan balance, it is called
negative amortization.
MORTGAGE PAYMENT CAP:
A mortgage payment cap is the maximum
allowable interest rate the lender can charge on your loan
regardless of what happens in the market. Depending on your particular
loan program, this is a percentage (usually 5% to 7.5%
annually) that can be added to your fully indexed rate
if the market warrants moving that high. For example,
if your fully indexed rate is 8% and your annual cap is
6%, your loans life cap would be 14%.
Mortgage payment caps were designed to limit unrestricted
increases by lenders and keep the borrowers payments at
a manageable level. Some lenders impose payment caps,
some impose interest rate caps and some lenders use both.
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NEGATIVE AMORTIZATION CAP:
A negative amortization cap
limits the amount of negative amortization that can be
reached on a loan. When
the cap is reached, the loan is re-amortized to a level
sufficient to pay off the loan over the remaining term
of the loan.
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CONVERSION OPTION:
A conversion option on an adjustable
rate mortgage is called a Convertible ARM. A conversion option gives
the borrower the option to convert their adjustable-rate
mortgage to a fixed-rate loan. Convertible Arm's
normally have a higher initial interest rate (even the
converted fixed rate will usually be higher). You
will usually have a time frame in which to convert the
loan to a fixed rate. For example, you might have
to make your decision to convert the loan sometime after
the first year and before the fifth year ends. In
most cases, there is also a conversion fee imposed on the
borrower (for instance 1% of the total loan amount).
There are many different ARM programs to choose from
with many available options. If you are considering
an adjustable-rate mortgage, we will be happy to explain
your options to you and make sure you have the right program
to meet your needs.
