Mortgage Information
Types of Mortgages
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Contents:
Fixed-Rate Mortgages
Adjustable-Rate Mortgages
2-Step Mortgages
Conforming & Non-Conforming Mortgages
Balloon Mortgages
(FHA) Federal Housing Administration Mortgages
(VA) U.S. Department of Veteran Affairs
Fannie Mae and Freddie Mac
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Fixed-Rate Mortgages
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Fixed-rate mortgages are traditionally
the most popular type of mortgage in America. They are typically
taken out over a 30-year period, but lengths of 15 to 25 years are
also available. The interest rate and monthly mortgage payment on
a fixed-rate mortgage remain the same throughout the entire life
of the loan. The main advantage of a fixed-rate mortgage is that
the borrower knows exactly what their monthly costs will be until
the entire mortgage has been completely paid out. The main disadvantage
is that the borrower pays a premium for this guarantee in the form
of slightly higher interest rates.
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Adjustable-Rate Mortgages
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With adjustable-rate mortgages the
interest rate is linked to current market rates and fluctuates with
economic changes. When interest rates go down, so do your mortgage
payments. When rates go up, your mortgage payments increase accordingly.
ARM interest rates are usually set lower than those found in fixed-rate
mortgage, at least at the beginning of the term. This means that
a homebuyer opting for an ARM will be able to qualify for a larger
loan since they are paying less interest. However, because ARM interest
rates fluctuate there is a level of uncertainty and risk involved
if economic conditions create long-term interest rate increases.
ARM interest rates are normally fixed for the first six months to
a year, after which they are pegged to some major economic index
such as the T-bill rate.
For adjustable-rate mortgages there are two "caps" on interest
rate increases. The "period of adjustment" cap determines how much
the interest rate is allowed to vary from one period to the next.
For example if the agreed upon period is every six months with a
period of adjustment cap of 1%, then the maximum interest rate increase
over that six-month period could not exceed 1%. The second cap puts
a ceiling on how high the interest rate can increase over the life
of the loan. For example, the maximum increase might be negotiated
to be 6%. This figure should be taken into account as the "worst-case
scenario" when considering this type of financing since the interest
rate could possibly rise by up to 6% from the initial rate. If you
are sure that you could afford these worst-case rates then you might
consider this type of mortgage since you would benefit if the rates
went down.
Another feature, which can sometimes add a level of comfort to
this type of mortgage, is a conversion feature. Having a conversion
clause in the mortgage gives the homebuyer the option to lock in
the interest rate at certain times during the term of the mortgage.
There is usually a conversion charge associated with this option.
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2-Step Mortgages
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A 2-step mortgage is a combination
of both fixed-rate mortgages and adjustable-rate mortgages. Generally
speaking, the first 5-7 years of the mortgage are treated like a
fixed-rate mortgage. During the remainder of the term, known as
the second step, the interest rate is allowed to fluctuate like
an adjustable-rate mortgage.
During the initial first step of a 2-Step mortgage the interest
rate is generally lower than for a fixed rate mortgage but higher
than for an adjustable rate mortgage. The benefit of this type of
mortgage is that it initially offers the homebuyer a lower interest
rate than those found in fixed rate mortgages while still retaining
the stability of a fixed payment and interest rate for the first
few years of the loan. The homebuyer still needs to keep in mind
that in the second step, or adjustable-rate portion of the mortgage,
the interest rate may move either up or down, depending on the economy.
As mentioned in the above section on Adjustable Rate Mortgages,
a mortgage conversion feature can sometimes add a cushion of security
to this type of mortgage.
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Conforming & Non-Conforming Mortgages
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A conforming mortgage refers to a
mortgage that is drawn up within the guidelines specified by the
lending institutions referred to as Fannie Mae
and Freddie Mac. The most common reason
for a mortgage to be referred to as non-conforming is because the
total amount of the mortgage exceeds the lending limits or total
loan amount allowed. This type of non-conforming loan is often referred
to as a Jumbo mortgage.
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Balloon Mortgages
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This type of mortgage is usually amortized
over the traditional 30-year period, but the actual length of the
loan, or the term, is much shorter. At the end of the term, the
homeowner must renegotiate a new mortgage at the new current interest
rates. The amount still owning at the end of a balloon mortgage
term (that is the original loan amount less the payments made against
the principle during the term) is then due in full. The homeowner
will then have to obtain a new mortgage (either another balloon
mortgage, or switch to a fixed-rate or adjustable-rate mortgage)
to replace the expired one. The benefit of a balloon mortgage is
that the interest rate is noticeably lower than that for traditional
30-year fixed-rate mortgages.
Please note that homebuyers need to understand that...
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Once a balloon mortgage is due their next mortgage
will be set at the new current interest rates, which could be
higher or lower than before. |
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They may not have a guaranteed renewal privilege and
may have to go elsewhere to obtain a new mortgage. |
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They may have to financially re-qualify for the next
mortgage. |
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Refinancing fees may be charged. |
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Federal Housing Administration Mortgages (FHAM)
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These are mortgages that are guaranteed
against default by the Federal government. Lenders are willing to
give mortgages to homebuyers with smaller down payments than under
conventional financing because the Federal government guarantees
the loan against default. The homebuyer must pay an insurance premium
for this privilege and this cost is usually added to the mortgage.
In order to qualify for an FHAM the property in question must meet
certain requirements. The maximum amount of loan allowed under this
system varies from region to region and is based on the average
price of housing in each area. You should contact your real estate
agent or mortgage specialist for further information.
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Veterans Administration Loans (VA)
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VA loans are restricted to qualifying
U.S. veterans for the purchase of a home with no down payment and
lowered closing costs.
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Fannie Mae and Freddie Mac
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Both Fannie Mae and Freddie Mac are
independent, privately run companies that operate under special
congressional charters. Their mandate is to ensure that mortgage
funds are made available to a broad spectrum of the American public.
They do this by buying mortgages from approved lenders and then
packaging those monies into securities backed by Fannie Mae/Freddie
Mac. Those securities are then sold to investors in the secondary
mortgage market. Fannie Mae and Freddie Mac are independently owned
companies that compete with each other for mortgage business. This
competition ensures that there is an ample supply of low cost mortgage
money available to the American homebuyer.
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