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.
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.
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.
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.
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
Please note that homebuyers need to understand
Once a balloon mortgage is due their next mortgage
will be set at the new current interest rates, which could be higher or lower
They may not have a guaranteed renewal privilege
and may have to go elsewhere to obtain a new mortgage.
They may have to financially re-qualify for
the next mortgage.
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 REALTOR or mortgage specialist for further information.
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
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