Mortgage Loan Types and Definitions

June 18, 2015

Mortgage Loan Types and Definitions

Every time that you make certain purchases especially home buying, a consumer should be able to know what sort of property they are getting, how much they will be paying, etc. This also includes shopping for mortgage. Well, it does not necessarily mean that you will be paying for the mortgage, but finding out which mortgage offer suits your needs and fits right into your budget.

The Basics

We might have heard the word “mortgage” a dozen of times, but what exactly does it mean and how does it work? A residential mortgage is a common legal agreement between an individual who borrows money from the bank or person to buy a property such as a house or a condominium. The agreement itself states that the borrower must repay the borrowed money and any interest to the lender (usually the bank/ person) on a predetermined schedule. If they fail to pay according to the said schedule, the lender has the legal right to take possession of or foreclose on the property, which is usually the collateral for the loan.

There are also common different types of mortgages available on the market. Here are some of them and their definitions:

Fixed- Rate Mortgage

Fixed-rate mortgages are paid over a period of 15, 20 or 30 years. The benefit of this type of loan is that the monthly interest and principal payments stays the same for the duration of the loan. There is no need to worry about interest rates spiking up or surging high due to the current market’s status.

Adjustable Rate Mortgage (ARM Loan)

In contrast to the fixed-rate mortgage, the adjustable rate mortgage is designed to adjust the market after an initial fixed rate period (usually a five-year period). The benefit to this type of mortgage is that initially it offers low interest rate but once the rates are adjusted it cause unpredictable swings in mortgage payments which could be difficult to budget for.

Interest Only Mortgage

During the first five or ten year period of the loan, the borrower only pays for the interest. This means that none of your payments are going towards the principal balance – and this is quite an advantage for people who are unable to fit a mortgage payment within their budget and expecting to improve their income over the next few years. At the end of the interest-only period, either a balloon payment for the principal of the mortgage may be due or the payments may increase to pay off the principal balance within the remaining period of the loan.

Private Financing

The benefit with private financing is that is a good option for people who have been through bankruptcy, foreclosure or other financial troubles and are looking to buy a house. This is a method where a finance company or an individual person may provide a mortgage loan to a non-conforming residential buyer who does not qualify for a bank loan. However, there are certain downsides to this option – they are likely to carry higher interest rates and are largely unregulated.

Seller Carryback or Hard Money Loan

These are also another option for potential buyers who do not qualify for a traditional bank financing but have enough cash for a down payment. Seller carryback occurs when the seller of the property finances a percentage of a loan, while hard money loan is when a mortgage designed to cover just the loan-to-value ratio on a property. A down payment or some kind of other collateral is required from the borrower to secure this type of loan.

VA Loans

This is available for service members who meet specific requirements from the Department of Veterans Affairs. The benefit is that they require no down payment and private mortgage insurance (PMI) to be able to secure this type of loan.

FHA Loans

This is a good option for first-time home buyers or buying a fixer-upper property. The Federal Housing Administration which is a division of HUD, insures some types of loans to make homeownership accessible through lower down payments and closing costs with more flexible credit requirements. There is also what they call “reverse mortgages” which are offered to senior citizens who have paid off most of their mortgage and want to turn their home equity into cash for living expenses.

In closing, its best to consult a home lender to determine which loan program would work best for your unique home buying situation. Contact me for a list of preferred lenders I work closely with to help my clients finance their home purchase.

Source: http://www.realestate.com/advice/definitions-of-loan-types-for-mortgages/