Loan Types


When shopping for a new mortgage, you need to make sure you thoroughly research the types of mortgage products available, as well as the lenders that offer them.

Lenders can come in a variety of different forms such as your local savings bank, a national and/or local mortgage company, online and government agencies.

Conventional Loans
Conventional loans are mortgages that can be issued by all lending institutions, excluding government sponsored programs. These loans include the following:
  • Fixed Rate Loans
  • Adjustable Rate Loans (ARMs)
  • Combination (Hybrid) Loans
  • Jumbo / Construction Loans
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Conforming Loans
Conforming loans are conventional loans that meet bank-funding criteria set by Fannie Mae (FNMA) and Freddie Mac (FHLMC). Both of these stock-holding companies buy mortgage loans from lending institutions and secure them for resale to the investment community. Every year, form October to October, Fannie Mae and Freddie Mac establish limits on what constitutes a conforming loan in a mean home price.

Buying back mortgage loans allow these agencies to provide a continuous flow of affordable funding to banks that reinvest their money back into more mortgage loans. Fannie Mae and Freddie Mac only buy loans that are conforming, to repackage into the secondary market - effectively decreasing the demand for non-conforming loans.

2006 Conforming Loan Limits:

Number of Units Maximum original principal balance Alaska, Guam, Hawaii, and U.S. Virgin Islands only
1 $417,000 $625,500
2 $533,850 $800,775
3 $645,300 $967,950
4 $801,950 $1,202,925

NOTE: The conforming loan limit in Alaska, Hawaii, Guam and the Virgin Islands is 50% higher.

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FHA Loan
FHA mortgage products are issued by lenders approved by the Federal Government and are backed by the U.S. Department of Housing and Urban Development.

FHA mortgages are ideal for first time home buyers as they are easier to qualify for and have lower down payment requirements.

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VA Loan
Designed to offer long-term financing to American veterans, VA mortgage loans are issued by federally qualified lenders and are guaranteed by the U.S. Veterans Administration. The VA determines eligibility and issues a certificate to qualifying applicants to submit to their mortgage lender of choice. It is generally easier to qualify for a VA loan than conventional loans.

Here's how it works:

  • 100% financing without private mortgage insurance or 20% second mortgage.
  • A VA funding fee of 0 to 3.3% (this fee may be financed) of the loan amount is paid to the VA.
  • When purchasing a homeveterans may borrow up to 100% of the sales price or reasonable value of the home, whichever is less.
  • When refinancing a home, veterans may borrow up to 90% of reasonable value in order to refinance where state law allows.

Apply for a VA Loan with a VA Qualified Lender.

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RHS Loan Programs
The U.S. Department of Agriculture offers a variety of programs to help low to moderate-income individuals living in small towns or rural areas achieve homeownership. The Rural Housing Service (RHS) helps qualifying applicants, who cannot receive credit from other sources, purchase modestly priced homes as their primary residence.

RHS Loans are an attractive option because:

  • Minimal closing cost
  • Low or no down payment

RHS loans can be used toward the purchase and renovation of a previously owned home or a new construction. Families must be able to pay their monthly mortgage, homeowner's insurance and property taxes.

Find out if you qualify for an RHS Loan.

Find an RHS-approved lender. (LINK)

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State and Local Housing Programs
Your state and local county governments have programs in place to help low to medium income families obtain financing for a home purchase. These programs offer tax credits and typically relaxed qualifying guidelines. Eligible home buyers will also receive lower, fixed interest rates. Apply Now
Jumbo Loans
Jumbo Loans exceed the maximum loan amounts established by Fannie Mae and Freddie Mac conventional loan limits. Rates on jumbo loans are typically a little higher than conforming loans. Jumbo Loans are typically used to buy more expensive homes and high-end custom construction homes.

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B/C Loans
B/C Loans do not meet the credit requirements of Fannie Mae and Freddie Mac. They are known as B, C and D paper loans. Loan applicants typically have a bad credit history, have filed for bankruptcy, or have had a property in foreclosure.

B/C Loans are often issues as temporary loans until the applicant can restore credit and qualify for conforming "A" loans. Interest rates on B/C Loans are generally higher than for conforming "A" loans.

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Location Efficient Mortgage (LEM)
Location Efficient Mortgages are available to individuals purchasing more expensive homes in areas where with efficient public transportation systems. These loans take into account monies saved on the expenses related to owning or leasing automobiles.

LEM loans are only available in certain markets:

  • Chicago, IL
  • Los Angeles, CA
  • San Francisco, CA
  • Seattle, WA

Find out more about LEMs.

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Fixed Rate Mortgage

A fixed mortgage guarantees the same monthly payment for the duration of the loan.

Payments on fixed-rate loans are amortized so at the end of your loan tern, wether its a 15 or 30 year, your property will be paid down. In the early stages of your fixed rate loan program, majority of the payment goes towards paying down the interest As the mortgage is paid down, the majority of your payment will pay down the principle.

A 30 year fixed rate mortgage is the most popular fixed program, as the monthly payment is lower. Some of the benefits include fixed interest rates, fixed payment amount and lower monthly payments.

A 15 year fixed rate mortgage is not as common but allows the homeowner to build equity faster and take advantage of a lower interest rate. If you have disposable income, this would be ideal as you can be debt free faster.

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Adjustable Rate Mortgage (ARM)
An ARM is a mortgage with an interest rate that may vary over the term of the loan -- usually in response to changes in the prime rate or Treasury Bill rate. The purpose of the interest rate adjustment is primarily to bring the interest rate on the mortgage in line with market rates.

Mortgage holders are protected by a ceiling, or maximum interest rate, which can be reset annually. ARMs typically begin with more attractive rates than fixed rate mortgages -- compensating the borrower for risk future interest rate fluctuations.

Choosing an ARM is a good idea when:

  • Interest rates are going down
  • You intend to keep your home less than 5 years

ARMs have the following distinguishing features:

  • Index
  • Margin
  • Adjustment Frequency
  • Initial Interest Rate
  • Interest Rate Caps
  • Convertibility

Index

An adjustable rate mortgage's interest rate increases and decreases based on publicly published indexes. ARMS are based on different indexes including:
  • United States Treasury Bills (T-bills)
  • The 11th District Cost of Funds Index (COFI)
  • London Interbank Offering Rate Index (LIBOR)
  • Certificate of Deposit Indexes (CODI)
  • 12-Month Treasury Average (MTA or MAT)
  • Cost of Savings Index (COSI)
  • Bank Prime Loan (Prime Rate)

Margin

Margin is fixed percentage pointed added to the index - accounting for the profit the lender makes on the loan. Margins are fixed for the term of the loan.

interest rate = index + margin

Adjustment Frequency

Adjustment frequency reflects how often the interest rate changes - also known as the reset date. Most ARMs adjust yearly, but some ARMs adjust as often as once a month or as infrequently as every five years.

Initial Interest Rate

The initial interest rate is the interest rate paid until the first reset date. The initial interest rate determines your initial monthly payment, which the lender may use to qualify you for a loan. Often the initial interest rate is less than the sum of the current index plus margin so your interest rate and monthly payment will probably go up on the first reset date.

Interest Rate Caps

Interest rate caps put limits on interest rates and monthly payments.

Common caps:

Initial Adjustment Cap

An initial adjustment cap limits how much the interest rate can change at the first adjustment period.

Example:

If your ARM has a 1% initial adjustment cap, your interest rate may only increase or decrease by a maximum of 1% at the first adjustment period.

Periodic Adjustment Cap

A periodic adjustment cap limits how much your interest rate can change from one adjustment period to the next. Usually a six-month adjustable rate mortgage will have a one percent periodic adjustment cap while a one-year adjustable rate mortgage will have a two percent periodic adjustment cap.

Example:

If your loan has a 2% periodic adjustment cap, your interest rate may only increase or decrease by a maximum of 2% per adjustment period.

Lifetime Cap

A lifetime cap sets the maximum and minimum interest rate that you may be charged for the life of the loan. Most ARMs have caps of 5% or 6% above the initial interest rate.

Example:

If your loan has a 6% lifetime cap, your interest rate may only increase or decrease by a maximum of 6% for the life of the loan.

Initial adjustment caps, periodic adjustment caps, and lifetime caps make up an adjustable rate mortgage's cap structure, and are usually represented as three numbers:

Example:

1/2/6 -- Initial adjustment cap is 1 %/ periodic cap is 2% / lifetime cap is 6%.

Negatively Amortizing Loans

Because Negatively Amortizing Loans provide payments caps instead of interest rate caps, they limit the amount the monthly payment can increase. However, there is a risk interest rates could potentially escalate to a point where the monthly payment would not cover the interest being charged. If this scenario were to occur, the extra interest charges would be added to the principle of the loan, resulting in the borrower owing more than was initially borrowed. Borrowers are usually allowed to make payments over the loan amount to pay down the mortgage and guard against this scenario.

There are certain times when having a negatively amortizing mortgage could be beneficial. If a borrower were to lose a job or have an unexpected financial emergency a negative amortization option could ease cash flow situation. However, this should only be used as a short-term solution.

Option ARM loans

Option ARM loans allow the borrower to choose the amount to pay toward the mortgage each month. Make a minimum payment, interest-only payment, 30-year amortized payment or 15-year amortized payment. Pay the minimum amount to free up funds for other uses, or make larger payments for faster equity build up. Option Arms offer much more cash flow flexibility but must be used wisely by the borrower. Always consult a qualified loan officer to learn about all of the risks associated with these types of loans. He or she will also be able to offer valuable advice on properly managing your monthly payments.

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Combined/Hybrid ARMs
A combination of fixed rate and adjustable rate loans:

Fixed-Period ARMs

Borrows often lock into 3 to 10 years of fixed rate payments before the initial interest rate change. At the end of the fixed period, the interest rate adjusts annually. Fixed-period ARMs are typically tied to the one-year Treasury securities index: 30/3/1, 30/5/1, 30/7/1 and 30/10/1.

ARMs with an initial fixed period beside of lifetime and adjustment caps usually have also first adjustment cap. It limits the interest rate you will pay the first time your rate is adjusted. First adjustment caps vary with type of loan program.

The advantage of these loans is that the interest rate is lower than for a 30-year fixed (the lender is not locked in for as long so their risk is lower and they can charge less) but you still get the advantage of a fixed rate for a period of time.

Two-Step Mortgage

Two-Step Mortgages offer a fixed rate for a specified time period, typically 5 or 7 years, and then adjust to the current market rate. After the adjustment the mortgage stays at the new fixed rate for the remainder of the loan period.

Graduated Payment ARMs

Graduated payment mortgages initially offer lower payments at the start of the loan that gradually increase at preset times. Lower initial payments allow borrowers to qualify for a larger loan amount. Loan amounts negatively amortize during the early years of the loan then pay off the principal at an accelerated rate through the later years.

GPM payment plans will vary by rate of payment increases and number of years over which payments will increase. The greater the rate of increase, or the longer the period of increase -- the lower the initial mortgage payments.

Convertible ARMs

If an adjustable rate mortgage is convertible, the borrower may convert to a fixed rate mortgage, when interest rates begin to rise, without refinancing. The new rate is established at the current market rate for fixed-rate mortgages. The terms of convertibility vary among lenders. Typically it involves a nominal fee and minimal paperwork. The downside is that the conversion interest rate is often a little higher than the market rate at the time of conversion.

A fixed rate loan with a rate reduction option allows borrowers, under predetermined conditions, to adjust to the current market rate for a nominal fee. The discount points or interest rates are often slightly higher for convertible loans.

Buydown Mortgage

A temporary buydown initially offers a lower interest rate and lower monthly payments. In order to reduce monthly payments during the first years, borrowers make an initial lump sum payment or agree to a higher interest rate. Over the years, the interest rate gradually increases until it peaks at a fixed rate. Borrowers who chose this loan often expect a significant increase in their income.

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