Understanding Different Types Of Mortgages

Understanding Different Mortgages

Balloon Loan

Out of the many types of mortgages, balloon mortgages may be the least used out of all of the different types of mortgages.

They are short term fixed rate loans which give you a set monthly payment based on a 30 year fully amortized schedule and a “balloon” payment at the end of its term.

A balloon mortgage can be advantageous as the interest rate charged is almost always lower than your standard 30 year fixed rate mortgage because terms are generally much shorter at 3, 5, 7 and 10 years which leads to lower monthly payments.

The disadvantage is that at the end of the term you will have to come up with a lump sum to pay off your lender, either through a refinance or from your own savings.

Balloon mortgages with refinancing alternatives do let borrowers convert their balloon mortgage at the end of the 3, 5, 7 or 10 year term period over to a new mortgage loan product.

These built in refinancing options are commonly based upon the outstanding principal balance, but only if particular considerations are met.

The tremendous advantage to having the built in refinance option is you will not need to qualify for the new loan or have the property reappraised. The interest rate on the new mortgage will consist of the current rate at the time of transition, but there should be only minimal fees charged in order to obtain the new loan.

Conforming Loan

Conforming loans are considered the main stream mortgage out of all types of mortgages on the market today. They consist of loans secured by Government Sponsored Entities (GSE’s), known as Freddie Mac (FRE) and Fannie Mae (FNM).

These agencies having been chartered by Congress since 1970 to increase the supply of funds to home buyers and multifamily investors, have the ability to pool large amounts of mortgage loans for resale to investors such as pension funds or insurance companies.

By doing this they lower their exposure to any one loan, which in turn allows your local mortgage company to offer you a lower interest rate then would otherwise be possible.

Freddie Mac and Fannie Mae are also responsible for establishing the uniform underwriting guidelines for conforming mortgage loans. These include suitable properties, credit, down payment and income.

The maximum conforming loan limits are set by the Office of Federal Housing Enterprise Oversight (OFHEO), a government agency responsible for regulating Freddie Mac and Fannie Mae.

Conventional Loan

A conventional loan is any mortgage loan which is “not” a VA (Veteran Affairs), FHA, RHS or a PIH loan. This includes conforming, non conforming, jumbo & subprime loans.

Jumbo Loan

Jumbo loans are defined as any loan that falls above the maximum conforming loan limits set by Fannie Mae and Freddie Mac. These loans will carry a slightly higher interest rate, although the spread is determined by current market conditions.

Negative Amortization Loan

These types of mortgages were certainly part of the reason for the 2008 crash in the financial market.

Negative amortization happens when the interest rates climbs to the point where the monthly mortgage payment doesn’t cover the interest payment due, any unpaid interest is added to your original loan balance, which in turn raises your loan balance higher and higher every month.

Although you do have the choice of making only minimum payments, one should think this option over very carefully as allowing the interest to accumulate on top of the unpaid balances is one of the many things that helped millions of homeowners lose their home to foreclosure in the great 2008-2009 recession.

Example:

Your mortgage has a payment cap of 10%. If your payment is $2,000 per month and interest rates rise, your new payment would normally be $2,500/mo (for example), but your capped payment is only $2,200. The other $300 will be added to your loan balance, making it harder and harder every month to refinance out of the negative amortization loan, it simply eats the equity in your home like a monster leaving few choices.

Negative amortization Option ARMs have only one advantage, the ability to own more house for a smaller monthly payment than anyone was previously able to do.

The negative amortization was complete junk as it was only designed to separate borrowers from their money and designed by the financial borrowers to keep their leveraged profits climbing. The huge risk associated with this loan never even came close to equaling the very small advantages it gave.

Certain ARMs (for instance, Option ARM loans) provide payment ceilings instead of an interest rate ceiling. This restricts the amount the monthly payment that is allowed to increase, but does allow the interest rate to soar above the monthly payment. If your mortgage loan has a payment cap but does not have a periodic interest rate ceiling, then the loan is likely to become negatively amortized.

With many ARMs, your looking at an interest rate adjustment every 3-10 years, but with the negatively amortized mortgage loans you can expect this to adjust monthly.

Many adjustable rate mortgages (ARMs) provide an initial interest rate lower than the fully indexed rate during the initial period of the Option Arm loan, which could be one month or a year or more. It is better known as the teaser.

ARMs are obtainable with 30-year terms and even a few with 15 to 40 year terms. Adjustable rate mortgages (ARMs) by and large they will have a lower initial interest rate than fixed rate loans.

Non Conforming Loan

Conforming loans do not fall under the guidelines set by Freddie Mac or Fannie Mae (GSE’s). These loans have a higher loan amount then allowed for a conforming loan (i.e. they are above $417,000 for 1 unit), and/or there are issues meeting the conforming underwriting guidelines with any of the following – credit, ratio, source of funds, employment history, unusual house, etc.

Keep in mind that even though you may still have an A-paper loan, if you fall into the non-conforming category you will usually end up paying a 1/4% or higher interest rate than if you were to receive a conforming loan.

These loans which have a smaller market are usually either sold to private investors or kept in the lenders portfolio which is the reason for the higher interest rate.

Subprime Loan

Whether a loan falls into the subprime market has to do with a few different factors, but the biggest is credit. You can have issues with your income, source of funds, length of employment, etc., but if your credit score, for what ever reason does not allow you to fall into the conforming, non conforming category you will likely be looking at a subprime loan.

As a general rule, any borrower with a score below 590 will almost certainly be looking at a subprime mortgage.

If your score is between 590 and 620 there is a very good chance you will also be looking at subprime mortgage loan, but with compensating factors such as a large down payment, many months of reserves and/or extremely low ratios, you may be able to procure a prime loan.

These loans as a rule, usually carry a substantial increase in the mortgage rate and prepayment penalties because of the higher risk for default versus A-paper/Prime loans.

If you find your only choice is a subprime loan you should look at it as a short term (2-3 year) solution (most will have a 2-3 year pre-payment penalty). During this time work hard on cleaning up your credit and then ultimately refinance into a lower rate loan as quickly as possible.

Opponents of sub-prime lending allege predatory lending practices have been an ongoing problem with these loans since there inception.

Those looking for loans that do not qualify for any of the above have unfortunately little choice but to pay the higher rates and fees because of the perceived risk to lenders or wait until they qualify for prime rate loans.

The decisions you make on a sub-prime loan can easily put you in a worse financial position down the road if great care is not taken, as these types of mortgages can be extremely dangerous.