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Mortgages
Mortgage
101
A Few Different Types of Mortgages
Fixed-Rate
This is typically the choice of home buyers who
want to know exactly what their payment will be month after month for the life of the loan.
Often, the holders of these mortgages are committing to the possibility of long-term residency. The interest
rate and the total monthly principal and interest payment remains the same throughout the life of the
loan, which usually is 30 years, but can be 10, 15, 20, or even 40 years.
Adjustable-Rate
This mortgage has steadily gained in popularity
in recent years. It enables a home buyer to secure a loan at a lower interest rate compared to
the going fixed rate. The lower, adjustable rate is typically locked in for the first year, or sometimes
just a few months, and then adjusts in subsequent years in relation to some economic index - such as the prime
lending rate or interest on one-year Treasury bills.
The rate can go up only a certain
amount in any given year, usually 1-2 percent. There is also a lifetime cap on the increase, usually 6 percent. So
an adjustable rate mortgage that is secured at 5 percent could climb to as high as 11 percent in three years
during a period of rapid inflation and rising interest rates.
The primary customers for such
mortgages are home buyers having trouble qualifying for a house at a fixed rate because of lack of income, lack
of down payment, or too high an existing debt-to-income ratio. With an adjustable-rate mortgage, such
buyers can qualify for a larger loan. If they're anticipating an increase in income or a lowering of debt that
will keep pace with the maximum increase in the rates, it's a safe move. Often these buyers end up
refinancing at a fixed rate once their income enables them to do so. An adjustable rate mortgage also is
attractive to home buyers who know they'll be staying in a house for only a few years.
Two-step
These mortgages could be described as a hybrid
of the fixed rate and adjustable rate mortgages. Typically,
such loans provide a fixed rate for the first five or seven years of a 30-year mortgage,
then revert to a fixed or adjustable rate (convertible or nonconvertible) for
the remaining 25 or 23 years.
The adjustable or fixed rate at the
end of the five- or seven-year periods is typically tied to some predetermined
index and will also include a margin for the lender. So the home buyer is accepting the
risk of facing potentially higher rates after the first five or seven years. But during the first
five or seven years, the interest rate is typically lower than the current 30-year fixed rate and
higher than adjustable rates. So, two-step mortgages enable home
buyers to secure a rate that's lower than the fixed rate, but doesn't have the
risk of the potentially rapid increase that comes with an adjustable rate. These mortgages are
especially attractive to home buyers who plan to move within a short time-frame - in this case,
five to seven years.
FHA
Not so much a mortgage type as it is a mortgage
program, Federal Housing Administration loans are backed by the U.S. government. That means
the lender is reimbursed by the federal government if the borrower defaults on the loan. The
primary benefit of the program is that it enables home buyers to purchase a home with a minimal down
payment. Typically, just 5 percent is needed, compared to the 20 percent down payment that's
usually needed to secure conventional financing. Some FHA programs enable certain first-time home buyers in
particular income brackets to buy a home with a down payment as small as 3 percent. The size of an FHA loan
is limited, based on the average cost of housing within a particular geographic area. So, typically, a borrower
using FHA financing in a large metro area where housing prices are steep, can borrow a much larger amount than
the home buyer shopping in a rural area with lower housing costs. While the down payment
qualifications are much easier to meet with FHA financing, that doesn't necessarily
translate to a better deal over the
life of the loan. Mortgage insurance premiums, required because of the minimal down payment, will make
monthly payments higher than conventional loan payments at the same interest rate.
VA
Another U.S. government loan program is the
Veterans Administration loan, which is primarily designed to enable qualifying veterans of the U.S.
military to buy a home with no down payment and minimal closing costs. Depending on your veteran status,
there is an origination fee that will add to the cost of using this financing.
A disabled veteran, for example, may
not need to pay any fee at all, while a reservist who hasn't seen active duty might pay the maximum fee,
which today can be as high as 3 percent.
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