Types of Mortgages and Loans

When considering a mortgage, there are a lot of different types of loans to consider. Here’s a rundown:

Federal Housing Administration Loans: The Federal Housing Administration (FHA) is a federal agency within the US Department of Housing and Urban Development (HUD). FHA's primary objective is to assist in providing housing opportunities for low- to moderate-income families. FHA has both single-family (one to four units) and multifamily (five or more units) mortgage-lending programs. The agency does not generally provide the funds for the mortgages but rather insures home mortgage loans made by private-industry lenders such as mortgage bankers, banks and savings and loans.

Homeowners with FHA loans usually have to make only a small down payment (about 3 percent of the value of the home). They also enjoy a lower interest rate -- between 0.5 percent and 1 percent below the interest rates on other mortgages. The downside is that they do indeed have to purchase private mortgage insurance, or as it's called under these loans, mortgage insurance premium (MIP).

Rural Homebuyers: Special loans also exist for people choosing to locate in a rural area. These loans are given to encourage economic development in depressed regions. The specifics of the program are similar to the FHA loan program but may not be as stringent with the income qualifications.

But you'd be surprised at what's considered a "depressed region." You can sometimes find these loans available in very nice areas that for one reason or another have managed to qualify. Be sure to ask if such a program exists in your area.

No matter what kind of loan you end up getting, though, there will be tax implications -- generally positive ones.

Fixed-Rate Mortgage: This is the plain-vanilla loan most people think of when considering a mortgage. You will owe a certain percentage of the loan as interest to the lender. This amount never changes, and your monthly payment will remain the same over the life of your loan. Loans for homes are usually 15 or 30 years.

Adjustable-Rate Mortgage: With an adjustable-rate mortgage (ARM), the interest rate changes to reflect changes in the credit market out in the great, wide world. The first-year rate (otherwise known as the teaser rate) is generally a couple of percentage points below the market rate. There are also upward limits above which the interest rate isn't allowed to go -- this is called the cap. If your teaser rate is 4 percent and you have a five-point cap, then the highest that your interest rate could go would be 9 percent.

What's more, the amount that the interest rate can rise each year is limited, usually to one or two percentage points per year. The frequency at which the rate adjusts may vary; make sure you know these features.

If you're considering an ARM, think about the worst-case scenario. What if interest rates go up and your ARM adjusts to its maximum? What will that maximum be, and when will it kick in? Will you be able to afford the payments?

Cost of Funds Index: One type of ARM is a cost of funds index (COFI) loan. This loan doesn't have any caps and adjusts monthly. It is, in a sense, the most adjustable ARM, since it isn't fixed for a certain time. But the index it’s tied to is the most stable index of them all: The rate banks have to pay their depositors to keep their money (e.g., checking accounts, savings accounts, certificates of deposit). It tends to be a slow-moving index. The COFI loan has certain advantages in that you can vary the amount of your payments as you wish (paying off more or less each month).

Hybrid Loan: Typically, a hybrid loan is fixed for one, three, five, seven or 10 years and then converts to an ARM. This means you get stability for a given amount of time, and then your fate is cast to the winds of the prevailing interest rates.

Two-Step Loans: These loans attempt to have the best of both worlds: The stability of a fixed loan with the lower rates of an ARM.

They appear in their most common forms as 5/25 or 7/23 loans. Math buffs among you will note that the numbers straddling those slashes add up to 30, as in a 30-year loan. This means your interest rate will be fixed for the first five or seven years, then the loan adjusts in one of two ways: It will either become an ARM, adjusting annually, or a fixed-rate loan. The beginning interest rate for these loans is generally lower than that of a standard 30-year fixed loan.

Balloon Loans: These tend to be short-term loans. You borrow money for, say, three or seven years, and the loan is amortized as though it were a 30-year loan. At the end of the three- or seven-year period, you owe the remaining principal in one lump sum. Again, these loans tend to have lower interest rates than the standard 30-year mortgage. If you're not planning to stay too long in your house, you might be interested in such a loan. The reason: You pay less in interest -- saving potentially thousands of dollars -- over the course of the loan than you would with a 30-year fixed. So you're less out-of-pocket when it comes time to sell.

Keep in mind that if your plans change and you want to stay in the house, you're going to have to pay off the loan in full -- by getting another loan, at the prevailing interest rates, and with the attendant costs of getting that new loan. So it isn't for the faint of heart or irresolute of mind.

Veterans Administration Loans: The more you know about loan programs, the more you will realize how little red tape there is in getting a Veterans Administration (VA) loan. These loans are often made without any down payment and frequently offer lower interest rates than what’s ordinarily available. Aside from the veteran's certificate of eligibility and the VA-assigned appraisal, the application process is not much different from any other type of mortgage loan. What's more, if the lender is approved for automatic processing, as more and more lenders are, a buyer's loan can be processed and closed by the lender without waiting for the VA's approval of the credit application.



Source: Monster.com