Most Loans Can be Repaid Over
a Term of 30 Years or Less
Most loans have equal monthly payments. The amounts can change from time to time on an ARM depending on changes in the interest rate. Some loans have short terms and a large final payment called a "balloon." You should shop for the type of home loan terms that best suit your needs.
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Loans can have a fixed interest rate or a variable interest rate. Fixed rate loans have the same principal and interest payments during the loan term. Variable rate loans can have any one of a number of "indexes" and "margins" which determine how and when the rate and payment amount change. If you apply for a variable rate loan, also known as an adjustable rate mortgage (ARM), a disclosure and booklet required by the
Truth in Lending Act
will further describe the ARM.
Mortgage Loan Types
There are many types of mortgages used worldwide, but several factors broadly define the characteristics of the mortgage. All of these may be subject to local regulation and legal requirements.
The two basic types of amortized loans are the
fixed rate mortgage (FRM) and
adjustable rate mortgage (ARM) (also known as a floating rate or variable rate mortgage). In many countries, floating rate mortgages are the norm and will simply be referred to as mortgages; in the United States, fixed rate mortgages are typically considered "standard." Combinations of fixed and floating rate are also common, whereby a mortgage loan will have a fixed rate for some period, and vary after the end of that period.
- Interest: interest may be fixed for the life of the loan or variable, and change at certain pre-defined periods; the
interest rate can also, of course, be higher or lower.
- Term: mortgage loans generally have a maximum term, that is, the number of years after which an amortizing loan will be repaid. Some mortgage loans may have no amortization, or require full repayment of any remaining balance at a certain date, or even negative amortization.
- Payment amount and frequency: the amount paid per period and the frequency of payments; in some cases, the amount paid per period may change or the borrower may have the option to increase or decrease the amount paid.
- Prepayment: some types of
mortgages may limit or restrict prepayment of all or a portion of the loan, or require payment of a penalty to the lender for prepayment.
In a fixed rate mortgage, the interest rate, and hence periodic payment, remains fixed for the life (or term) of the loan. In the
U.S., the term is usually up to 30 years (15 and 30 being the most common), although longer terms may be offered in certain circumstances. For a fixed rate mortgage, payments for principal and interest should not change over the life of the loan, although ancillary costs (such as property taxes and insurance) can and do change.
In an adjustable rate mortgage, the interest rate is generally fixed for a period of time, after which it will periodically (for example, annually or monthly) adjust up or down to some market index. Common indices in the U.S. include the Prime rate, the London Interbank Offered Rate (LIBOR), and the Treasury Index ("T-Bill"); other indices are in use but are less popular.
Adjustable rates transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where fixed rate funding is difficult to obtain or prohibitively expensive. Since the risk is transferred to the borrower, the initial interest rate may be from 0.5% to 2% lower than the average 30-year fixed rate; the size of the price differential will be related to debt market conditions, including the yield curve.
Additionally, lenders in many markets rely on
credit reports and credit scores derived from them. The higher the score, the more creditworthy the borrower is assumed to be. Favorable interest rates are offered to buyers with high scores. Lower scores indicate higher risk for the lender, and higher rates will generally be charged to reflect the (expected) higher default rates.
A partial amortization or balloon loan is one where the amount of monthly payments due are calculated (amortized) over a certain term, but the outstanding principal balance is due at some point short of that term. This payment is sometimes referred to as a "balloon payment" or bullet payment. The interest rate for a balloon loan can be either fixed or floating. The most common way of describing a balloon loan uses the terminology X due in Y, where X is the number of years over which the loan is amortized, and Y is the year in which the principal balance is due.
Interest Rate,"Points" & Other Fees. Often the price of a home loan is stated in terms of an interest rate, points, and other fees. A "point" is a fee that equals 1 percent of the loan amount.
Points are usually paid to the lender, mortgage broker, or both, at the completion of the
escrow. Often, you can pay fewer points in exchange for a higher interest rate or more points for a lower rate. Ask your lender or mortgage broker about points and other fees.
A document called the Truth in Lending Disclosure Statement
will show you the "Annual Percentage Rate" (APR) and other payment information for the loan you have applied for. The APR takes into account not only the interest rate, but also the points, mortgage broker fees and certain other fees that you have to pay. Ask for the APR before you apply to help you shop for the loan that is best for you. Also ask if your loan will have a charge or a fee
for paying all or part of the loan before payment is due ("prepayment penalty"). You may be able to negotiate the terms of the prepayment penalty.
Lender-Required Closing Costs. Your lender may require you to obtain certain closing services, such as a new title search,
mortgage insurance or
title insurance. A lender may also order and charge you for other closing-related services, such as the
credit report. A lender may also charge other fees, such as fees for
loan processing, document preparation, underwriting, flood certification or an application fee. You may wish to ask for an
estimate of fees and settlement costs before choosing a lender. Some lenders offer no cost” or "no point" loans but normally cover these fees or costs by charging a higher interest rate.
Comparing Loan Costs. Comparing APRs may be an effective way to shop for a loan. However, you must compare similar loan products for the same loan amount. For example, compare two 30-year fixed rate loans for $100,000. Loan A with an APR of 8.35% is less costly than Loan B with an APR of 8.65% over the loan term. However, before you decide on a loan, you should consider the up-front cash you will be required to pay for each of the two loans as
Another effective shopping technique is to compare identical loans with different up-front points and other fees. For example, if you are offered two 30-year fixed rate loans for $100,000 and at 8%, the monthly payments are the same, but the up-front costs are different:
Loan A - 2 points ($2,000) and lender required costs of $1800 = $3800 in costs. Loan B - 2 1/4 points ($2250) and lender required costs of $1200 = $3450 in costs.
A comparison of the up-front costs shows Loan B requires $350 less in up-front cash than Loan A. However, your individual situation (how long you plan to stay in your house) and your tax situation (points can usually be deducted for the tax year that you purchase a house) may affect your choice of loans.
Lock-ins. "Locking in" your rate or points at the time of application or during the processing of your loan will keep the rate and/or points from changing until settlement or closing of the escrow process. Ask your Travis Air Force Base California lender if there is a fee to lock-in the rate and whether the fee reduces the amount you have to pay for points. Find out how long the lock-in is good, what happens if it expires, and whether the
lock-in fee is refundable if your application is rejected.
Tax and Insurance Payments. Your monthly mortgage payment will be used to repay the money you borrowed plus interest. Part of your monthly payment may be deposited into an "escrow account" (also known as a "reserve" or "impound" account) so your lender or servicer can pay your real estate taxes, property insurance, mortgage insurance and/or flood insurance. Ask your lender or mortgage
broker if you will be required to set up an escrow or impound account for taxes and insurance payments.
Transfer of Your Loan. While you may start the loan process with a lender or
mortgage broker, you could find that after the escrow closes, another company may be collecting the payments on your loan. Collecting loan payments is often known as "servicing" the loan. Your lender or broker will disclose whether it expects to service your loan or to transfer the servicing to someone else.
Private mortgage insurance and
government mortgage insurance protect the lender against default and enable the lender to make a loan which the lender considers a higher risk. Lenders often require mortgage insurance for loans where the
down payment is less than 20% of the sales price. You may be billed monthly, annually, by an initial lump sum, or some combination of these practices for your mortgage insurance premium. Ask your
lender if mortgage insurance is required and how much it will cost. Mortgage insurance should not be confused with mortgage life, credit life or disability insurance, which are designed to pay off a mortgage in the event of the borrower's death or disability.
You may also be offered "lender paid" mortgage insurance (LPMI). Under LPMI plans, the lender purchases the mortgage insurance and pays the premiums to the insurer. The lender will increase your interest rate to pay for the premiums -- but LPMI may reduce your closing costs. You cannot cancel LPMI or government mortgage insurance during the life of your loan. However, it may be possible to cancel private mortgage insurance at some point, such as
when your loan balance is reduced to a certain amount. Before you commit to paying for mortgage insurance, find out the specific requirements for cancellation.
Flood Hazard Areas. Most lenders will not lend you money to buy a home in a flood hazard area unless you pay for flood insurance. Some government loan programs will not allow you to purchase a home that is located in a flood hazard area. Your lender may charge you a fee to check for flood hazards. You should be notified if flood insurance is required. If a change in flood insurance maps brings your home within a flood hazard area after your loan is
made, your lender or servicer may require you to buy flood insurance at that time.
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