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Loan Programs

Fixed Rate

The standard mortgage program is a 30 year fixed rate, where your monthly principle and interest payments are constant for the duration of the loan term. Taxes and insurance could of course vary should your tax assessed value on your home go up or if your homeowner's policy increases. Fixed rate loans are usually offered for 15, 20 or 30 years and in some cases even 40 years. This is the most secure type of mortgage to take, especially if you plan on staying in your home for a long while. You will pay a higher interest rate (than you would on an adjustable rate mortgage) for the extra security.

At the beginning of the loan repayment period, about 85% of your payment is applied toward interest, and the rest pays down your principle balance. This ratio shifts each month, adding a little more to the principle column and a little less towards the interest.

Lenders know that most mortgagors refinance or sell their home within 3-5 years, so this is their insurance against an early payoff.

Most customers make their payments at the beginning of the month, however some elect to make bi-weekly payments which have the effect of making an extra monthly payment each year. This will cut your mortgage term down to 24 years from 30. And making larger payments to your mortgage company every month will also shave years off your term and can save you tens of thousands of dollars, because the overage is applied to your principle balance.

Adjustable Rate Mortgages

Adjustable rate mortgages (ARMs) offer a lower introductory rate for a fixed period of time ranging anywhere from 1 month up to 10 years. As a rule, the shorter the introductory rate period, the lower the introductory rate. But after the introductory rate phase is up, the rate becomes variable.

ARMs are good for people who will be occupying a property short term, for investors buying and selling properties, and for new homeowners as a way to better afford their mortgage for the first few years.

How does the rate adjust after the introductory period? Depending on what kind of ARM loan you take, the interest rate will be tied to a certain INDEX (Libor 6 month, 1 year Treasury, 6 month CD or the 11th district Cost of Funds Index) and will adjust with that index at predetermined intervals. The most popular are the 1 year Treasury index and the Libor index (London Interbank Offered Rate). If you select the 6 month Libor index, then your rate will adjust every 6 months. If you select the 1 year Treasury index your rate will adjust once a year. All of the indices will fluctuate and most of them are published daily in the Wall Street Journal. The bottom line is if rates go up, then your rate will adjust upward and if they go down, your rate will drop.

An ARM loan consists of an INDEX and a MARGIN that is added to the particular index you've chosen. This yields what is called the fully indexed rate. Margins are determined by the lender and range from 1.75% to 5.5% depending on the particular index, loan to value ratio, credit risk, etc. The index and margin come into play after the introductory period. The fully indexed rate can rise dramatically, however your rate is protected from going much higher using interim and lifetime caps.

Interim caps limit how high the rate can adjust during the adjustment phase of the loan.

Typically, you will see an interim cap of 1% - 3% higher on the first adjustment and subsequent adjustments limited to 2% every adjustment period. There are also caps that limit the amount an interest rate can fall which are usually 1% less than the previous rate.

Arm loans also have a lifetime cap, meaning the payment rate can never exceed a certain percentage above the introductory rate. Usually a lifetime cap will be 5 - 6% above the introductory rate. This limits the upside risk for the homeowner.

Interest Only Mortgages

An interest only loan is pretty simple: it strips off the principle portion of the payment and allows you to only make the interest payment every month. This lowers the monthly mortgage payment, but it does not pay down the principle balance. The interest only phase is usually for the first 10 years after which time, the original loan balance is amortized over the remaining term. This assumes you don't pay extra during the interest only phase, which borrowers are in fact able to do with no penalty. If you do pay more than interest, then that overage is deducted from your principle balance and the final remaining balance will be re-amortized at the end of the interest only phase.

Interest only loans are popular with homeowners who have higher value homes because they save a few hundred dollars a month and they expect to build equity not by paying down the principle balance but by home appreciation. They are also popular with real estate investors for increasing cash flow, and regular borrowers who want a lower payment and who anticipate moving in a few years. Although the balance does not increase with interest only loans, they still carry risk, particularly in a declining market. It's possible that a home's value can fall below the balance and would leave the homeowner in a situation of negative equity.

Balloon Mortgages

Balloon Mortgages are a bit more complex and should be taken only if the situation is right. These loans are similar to ARM loans in that they have a fixed rate introductory period with a low rate. However they do not amortize over the course of the loan, rather the balance becomes due in full after the introductory period. So if you want a balloon mortgage, you should either anticipate being able to pay off the mortgage in full before that time, anticipate selling before then, or be sure you will be refinancing. But you may not be able to sell or refinance down the road as conditions like the housing market and mortgage markets are always changing as well as your credit profile.

Some balloon mortgages have conversion features where you can automatically refinance your mortgage at market rates plus a small addition to the rate. But frequently such features come with a caveat that your current mortgage be in good standing for the last 24 months. These balloon mortgages are called a 7/23 or a 5/25 convertible balloon.

Payment Option Loans or Negative Amortization Loans

Payment option loans or Pay Option ARMs were popular the last few years. This type of loan offered 4 payment options to the borrower, hence the name Pay Option Loan. Borrowers liked the flexibility of having 4 payment options - however this loan proved to be very dangerous and is thought to be responsible for many recent foreclosures.

The pay option arm's main attraction is that it offered a minimum payment rate for up to a period of 5 years that was usually between 1% - 4%. This rate was well below the fully indexed rate and results in negative amortization. Though the loan type offers 4 options (30 year fixed, 15 year fixed, interest only and the minimum payment) most homeowners chose to make the minimum payment. This means they are not paying the full interest payment so the remaining interest gets added to their principle balance. If the housing market starts to drop (as it has since 2006), the homeowner's balances will increase, they and they will eventually become upside down in their mortgage. This exact scenario exploded in the last two years prompting many of homeowners with pay option mortgages to foreclose and walk away.

The pay option can be used successfully in situations, but it is a more complex loan and should be accepted only after careful consideration. Most of these loan options have disappeared, although a few lenders still offer the pay option.