Fixed Rate Loans
By far the most popular type of mortgage loan, fixed rate loans typically come in 30, 25, 20, 15, and 10 year terms. The interest rate agreed is guaranteed to remain the same until the loan is paid off. Principal reduction payments and interest payments are paid on a monthly basis, often times combined with homeowner's insurance (hazard insurance), property taxes and sometimes mortgage insurance payments to make the total payment.
These loans are utilized in both purchase and refinance situations and offer no future risk.
Adjustable Rate Mortgages (ARM)
These loans have a set period of time that the interest rate is fixed and then the interest rate will adjust dependent upon current market conditions. The principal and interest payments on these loans are most often calculated based on a 30 year term, but have shorter terms where the interest rate is fixed. For instance, a 1 Year ARM is fixed for 1 year and then becomes adjustable; a 3 Year ARM is fixed for the first 3 years before the interest rate adjusts; a 5 Year ARM is fixed for the first 5 years before adjustment, etc. These loans adjust based on a particular "index" such as the 1 Year Treasury Bill or 1 Year LIBOR (London Interbank Offered Rate). They have an agreed upon "margin" which is added to the "index" at the appropriate time of adjustment to become the new interest rate. These loans also typically have a maximum amount the interest rates can adjust at each time of adjustment and a maximum amount the rate can adjust over the life of the loan. These are called Periodic Adjustment Caps and Lifetime Adjustment Caps. This ensures and protects you from outrageous adjustments. Meaning that your interest rate can not suddenly adjust 10% with little warning. They often offer lower starting interest rates than fixed rate loans.
These loans are utilized for several purposes. If you are anticipating only spending a certain amount of time owning the home, you may match that time frame with the initial fixed period of the mortgage. For instance, if you only plan on owning the home for 3 years, than a 3 Year Adjustable Rate Mortgage would allow the interest rate to stay fixed for the 3 years you plan on owning the home and would allow you to enjoy a lower interest rate for those 3 years than a fixed rate loan with no pre-payment penalty.
They are also used as interim financing loans. This means that if the fixed interest rates are higher than you want, the adjustable rate would allow you to enjoy a lower interest rate until the fixed rates come back down. This presents a higher risk level as you are anticipating the fixed rates to drop during the initial term of your ARM loan. For instance, a 5 Year ARM stays fixed for the first 5 years. You are anticipating the fixed rates are going to drop during that initial 5 year period. Lance can help assess if this risk is worth taking in comparison with the lower interest rates of the ARM.
They are also used to enable a buyer who has good future earning potential to qualify for a little more home knowing that in the future they will be able to pay a higher mortgage payment through an adjustment, or refinancing the loan into a fixed rate.
Balloon Loans
Balloon Loans are mortgage loans that also have a set period of time in which the interest rate is fixed; however, at the end of that period of time, the remaining principal balance is to be paid off in full in a balloon payment. The principal and interest payments on these loans are most often calculated based on a 30 year term. Sometimes, these loans have a "conversion option", meaning that at the end of the initial term, an option exists to convert the balloon payment into a fixed rate mortgage at current market interest rates.
These loans are utilized for many the same reasons as the Adjustable Rate Mortgages. If you are planning on owning the home for a set period of time, such as 5 years, then a 5 Year Balloon mortgage would allow for that period of time to have a fixed rate with the anticipation of either selling or refinancing at the end of that time. These also present some risk and should be discussed with Lance whether this is a good program for your particular situation.
2/1 Buydowns
2/1 Buydowns are fixed rate loans where the lender buys down the interest rate 2% for the first year and 1% for the second year. As of the third year of the loan, the interest rate stays fixed for the remainder of the term. The loan is set for a 1% adjustment after year 1 and year 2. It is not dependent on what the interest rate market is doing. The actual dollars are pre-paid for the difference in interest payments. For instance, if you choose a 2/1 Buydown at 8%, this means that the actual loan is based on an 8% 30 Year Fixed mortgage; however, either the lender, the seller, or the buyer is paying the dollar difference between an 8% rate and a 6% rate for 12 months and the difference between an 8% rate and a 7% rate for the next 12 months. This dollar amount is paid up front at the time of closing. This presents less risk because the adjustment is guaranteed without any question as to the interest rate at the time of adjustment. Buydowns are only available on purchase transactions.
These loans are used to help the buyers "grow" into more expensive houses with the anticipation that the buyer's mortgage payment will increase as their earnings grow, or pay off current debt within first two years, or because they are anticipating fixed rates will drop to a level where a refinance would be advantageous.
