Do you want to know about the different types of mortgage loans? Okay, I’ll explain here in full. Maybe you’ve seen or even seen mortgage advertisements on the internet, TV, or newspapers.
Advertisers compete to offer various interest rates. In addition, they also offer many loans. No half-hearted, they claim to have hundreds of loan programs that you can choose. This is a real mortgage business competition.
But is it true that there are so many types of home mortgages out there? Actually no. Basically, there are only two types of loans, namely fixed rate and adjustable rate. As I said this is a marketing strategy. They just want to show you if they have a lot of programs to pick compared to other competitors.
Fixed Rates Mortgage
Understanding fixed rates aren’t difficult. Yes, when your mortgage is approved, the interest rate will not change or constant. Therefore, make sure you get the best deal for this matter.
In addition, you also need to know the amortization period. Whether it’s 10, 15, 20, 30 or 40 years as per Fannie Mae and Freddie Mac guide. Or it can be in accordance with the offer from the lenders. So throughout that period, your monthly mortgage payments will remain the same. Until you pay off your total loan.
Consider the following table:Florida's interest rates and payments on several mortgage terms with a credit score of 680 - 740 and 5% - 20% down.
|Mortgage terms||Fixed rates||Loan||Total Payment||Monthly Payment||Lender made|
|10 Years||3.43||$ 200,000||$ 236,539.90||$ 1,971.17||$ 36,539.90|
|15 Years||3.58||$ 200,000||$ 258,774.34||$ $ 1,437.64||$ 58,774.34|
|20 years||3.95||$ 200,000||$ 289,607.48||$ 1,206.70||$ 89,607.48|
|30 years||4.16||$ 200,000||$ 350,413.48||$ 973.37||$ 150,413.48|
You can see in the table that the longer the loan period, the smaller the monthly payment. But, the total loan repayments are higher. The same goes for the income of lenders.
Many online mortgage calculators that you can use to calculate easily. You can also download excel files to calculate fixed-rate mortgages payments here.
You need to know that when starting payments in the early years, fixed rates are more used to pay interest than to pay the principal. By speeding up the loan term for example from 30 years to 15 years you can pay the principal faster, but your monthly payment is higher. However, the total amount of your loan plus interest will be lower if you take shorter mortgage terms.
Say we use the same example for $200,000 loan amount, 30-year amortization, 4.16% rates. After 10 years the principal payment amount is $ 41,585.21 and the loan balance is $ 158,414.79. Whereas for the 15-year mortgage, same interest rates, the principal payment after 10 years is $ 119,115.26 and the loan balance is $ 80,884.74. Try to observe, higher payments mean faster loan repayments.
A balloon payment is another option for fixed-rate mortgages, such as 30/5 loan. This loan payment is a borrower’s option if they think to pay off the mortgage faster. In addition, lenders can provide fantastic lower rates. For example, a 30/5 loan may have an interest rate of 3.90% instead of 4.16% as in conventional loans.
30/5 loan means your amortization is 30 years. But after making monthly payments, on the 60th payment (year 5 is payoff time) you have to pay the remaining loan plus interest on that month (balloon payment). Because you have the intention to pay off your loan faster, the lender gives you a lower interest compared to a conventional fixed rate loan.
- Loan amount : $ 200,000
- Annual rates: 3.90%
- Amortization period: 30 years
- Number of payments: 60 months
- Monthly payment: $ 943.34
- Balloon payment: $ 181,544.38
- Total payments: $ 237,201.44
- Total interest paid: $37,201.44
Adjustable Rates Mortgages
Unlike fixed rates, ARM interest changes over the period of certain mortgage payments. But this change has a pattern or for example once a month or year, or once every two years. There are 3 points that you need to understand when you choose the ARM program. That is:
The index is a benchmark for calculating mortgage interest rates based on current market conditions. So the interest rate will be adjusted to the independent index. There are several different indexes, but what is commonly used is the Treasury bill or T-bill and LIBOR (London InterBank Offered Rates). In addition, there are also COFI (Cost of Fund Index).
3 Important Things About the ARM Index
Before lenders use the index, there are three important things that must be considered.
- It must be beyond the control of the lender.
- The index must be open publicly and easily verified. People can easily get information through the internet, newspapers, and other information media.
- When the index starts, it cannot be changed. For example, lenders start using LIBOR, they may not leave it and go with COFI. But there are rules where it can change. That is when the index is no longer available or published. Not only that, when they switch to another index, they have to verify that the index company they choose has the same tendency as the index they used before.
Banks as lenders have money. Margin is money in banks as financial institutions. One important thing is that during the loan term the margin is always fixed. Once set by the bank the margin value will not change.
The cap rate in ARM will inform the parties related to the mortgage about how high the percentage rate will go up for a certain period of time on the loan. Therefore there are two types of cape rates, namely:
- Lifetime cap rate
- Annual cap rate
- Margin: 2%
- Index: 4%
- Rate: 6% (This is the sum of margin and index percentage).
- Lifetime cap: 6%
- Annual cap: 1%
So for lifetime cap, the highest rate for all over mortgage terms is 6% + 6% = 12%. While for annual cap, the highest rate in one single year given is 6% + 1% = 7%.
Hybrid mortgages are a combination of fixed and ARM. The implementation of the mortgage will run with a fixed rate for several years and then it will turn into an annual or semi-annual ARM.
Generally, this mortgage is known as 5/1. This means it’s fixed for 5 years then switches to annual one-year ARM. There are also 7/1 with a fixed 7 years and switches to annual one-year ARM. Another loan is 5/6, with six-month ARM.
Many people choose hybrid because they believe that they don’t want the mortgage to be too long or because of some circumstances. For example, someone will move to another location within a period of 5 years then that person can choose a hybrid mortgage 5/1 or 5/6. Thus, they can avoid ARM interest on annual adjustments while getting lower interest rates compared to 30-year fixed loans.
Interest-only is an ARM type loan. As the name implies, you only pay monthly loan interest. As you know, part of the mortgage consists of principal and interest. With an interest-only, you just don’t pay down at all.
Now let’s compare, for example between a 30-year loan, $ 200,000, using a fixed rate and interest-only. The rate is 5.5%. Your monthly payment for fixed rates is $ 1,135.58 and $ 916.67 for interest-only. So consider if you hear mortgage advertisements that say they can reduce a certain amount of monthly payments. It could be just an interest-only loan program.
But remember, after several years of payment, say 5 years, you only pay interest on the loan. You don’t pay the principal at all. Therefore you must consider the decisions you make with this loan. You can be in a financially dangerous situation if you only want this loan to qualify and get your payment down.
The biggest risk of this loan is when the prices of houses or real estate fall. The result is that the house will lose its equity. House prices are always changing. And when if homes don’t appreciate, for example, a few years in the future, you like getting a double punch right on your face. You have to pay a much more expensive loan and you risk being unaffordable as a homeowner.
This loan is suitable for those of you who can pay the loan principal regularly and benefit from appreciation. Investors also often use these loans to buy properties for rent. Thus they always have a positive income turnover. In addition, if you are a seasonal worker or your income is irregular, you can consider getting an interest-only loan. Because you can make large payments according to your seasonal income.
ARM options provide a choice of how the borrower will pay the mortgage. But actually this is a requirement where the minimum payment option must be in accordance with the requirements of your record, the payment is amortized in full and based on the margin plus the index.
Don’t be fooled by this loan because when you pay a low monthly loan, the difference to the full index payment will be added to your original loan.
Loan amount: $500,000
Minimum monthly payment: 1%
Fully indexed payment: 4%
Monthly payment: $ 416.67
Fully monthly indexed payment: $1666.67
Difference between monthly payment and full indexed: $ 1,250
So the amount of $ 1250 will be added to your original loan. Therefore, you can imagine what happens if you make low payments every month!
This is a negative amortization, which means that the loan is actually not getting smaller, but actually getting bigger when the borrower pays it.
There are many other types of loans that you can choose. Other loans can certainly be better than you have to choose this type of loan. Because when you feel comfortable with very low monthly payments, and when you get hit with a full index payment, this can be a foreclosure. Yes, the ARM option can make you uncomfortable behind how easily you make low monthly payments.
But if you are sure about this loan and know how it works then you can consider it. Most real estate investors choose this loan because they can pay lower monthly payments and the rest can be used for other investment needs such as vehicles or stocks. You can also consider it when you don’t want to keep your property for a long time.
But it isn’t wise if you make option ARM as the primary choice in the mortgage loan while others are better without the huge potential for foreclosure.