Types of Mortgages
When in the market for a new home, few people have enough money saved up to purchase the home up front. This is why most homes today are purchased using a mortgage, which is a type of loan that uses the home and land as collateral for the borrower. There are a number of different types of home mortgages, so as a borrower, it is very important to understand what options are available.
Standard Mortgages: The traditional mortgage, or conventional loan are the most common type of home mortgage. These are offered for 15, 20, or 30 years and are often referred to as fixed-rate mortgages. This is because the interest rate will remain the same for the entire length of the loan. Typically, these are reserved for borrowers with excellent credit, although this is not always the case.
Adjustable Rate Mortgages (ARM): An Adjustable Rate Mortgage is today very popular and allows a new homeowner to receive an initial mortgage payment that is lower than you would get with a fixed rate mortgage. The borrower will receive an initial interest rate, which will remain fixed for between 1 and 10 years. After that, the interest rate is reevaluated and will likely increase. As an example, you might have a five year ARM, with an initial interest rate of 4%. after the initial period, the interest rate will be reevaluated every 5 years. A cap will be placed on both how high the interest rate can go each time it is changed, as well as how high it can go total.
The advantage of an adjustable rate mortgage is that the first few years will typically be considerably lower than that of a fixed rate mortgage. However, it is important to be very careful with these types of loans, because the mortgage payment can greatly increase when the interest rate changes. Many of those who are currently having problems in the housing market received subprime ARMs and are now unable to afford the increased payments.
Interest Only Loans: Interest Only Loans are typically only popular with investors and some credit these types of loans with increasing the numbers of foreclosures. In an interest only loan, the borrower will only pay interest on the home for up to 7 years. At the end of the period, they have the option to refinance, pay for the home, or have their interest only payments increased.
In addition to those who are buying a home with the sole intention of selling it, interest only loans are also popular among those who are expecting to receive a large payment, such as an inheritance.
Zero-Down Mortgages: A Zero-Down mortgage is simply a mortgage that does not require any down payment from the borrower. These can be a little bit dangerous, because the homeowner goes into the loan without any equity in their home.
Forty Year Loans: A forty year loan is similar to a conventional or fixed rate loan, except instead of only being for 15 or 30 years, it is for 40 years. This results in a monthly payment that is considerably lower, but because the duration of the loan is 10 years longer than normal, it means the house will end up costing the homeowner a great deal more than if they had financed it for even 30 years. This type of loan might be a good idea for investors who want a lower initial payment, but plan on paying off the home early or refinancing, but it is not typically advised to keep the loan for the entire 40 years.
Loan-to-Value Mortgages: A Loan-to-Value Mortgage are considered to be very risky, but are popular with those who do not have money for a down payment. In a Loan-to-Value Mortgage, the loan amount is based off of 100%, or in some cases more, of an appraisal of the homes value. If home prices start to decline, such as is currently occurring, this can turn out to be very bad for the borrower. These types of loans are also called 100 Plus Loans or LTV Loans.
Piggyback Loans: A pigglyback loan is available for those who are unable to pay a 20% down payment, which is often required with a conventional loan. Instead, the borrower will put 10% down and finance 80% of the homes value. They will then take out another loan for the remaining 10%, which is at a much higher interest rate. A Piggyback Loan is also often called a 80/10/10 loan, due to the way the mortgage is financed.
Negative Amortization Loans: In a Negative Amortization Loan, the borrower does not actually pay enough every month to cover the cost of the principal and interest on their loan. As a result, the balance of the loan actually increasings every month. These types of loans are very dangerous, but some people use them with the intention of refinancing at a later time.
Seller Financing : Sometimes, when a borrower is unable to qualify for a traditional mortgage, a seller will act as a lender. The borrower will pay the seller every month and this type of loan is often carried out between parities that know each other, because there is a good deal of trust required on both sides. If choosing to go with seller financing it is in the best interest of both the seller and the buyer to consult with an attorney.