Thursday, March 17, 2011
Mortgage loan types
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.
- 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 loer.
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.
The two basic types of amortized loans are the fixed rate mortgages (FRM) and adjustable rate mortgages (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.
In a fixed rate mortgage, the interest rate, and hence periodic payment, remains fixed for the life (or term) of the loan. Therefore the payment is fixed, although ancillary costs (such as property taxes and insurance) can and do change. 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,
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.
The charge to the borrower depends upon the credit risk in addition to the interest rate risk. The mortgage origination and underwriting process involves checking credit scores, debt-to-income, downpayments, and assets. Jumbo mortgages and subprime lending are not supported by government guarantees and face higher interest rates. Other innovations described below can affect the rates as well.
Depending upon the circumstances, there are various other methods, clauses, and innovations involving mortgages. Graduated payment mortgage loan have increasing costs over time and are geared to young borrowers who expect wage increases over time. Balloon payment mortgages have only partial amortization, meaning that 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, and at the end of the term a balloon payment is due. When interest rates are high relative to the rate on an existing seller's loan, the buyer can consider assuming the seller's mortgage.[5] Budget loans include taxes and insurance in the mortgage payment;[6] package loans add the costs of furnishings and other personal property to the mortgage. Buydown mortgages allow the seller or lender to pay something similar to mortgage points to reduce interest rate and encourage buyers.[7] Homeowners can also take out equity loans in which they receive cash for a mortgage debt on their house. Foreign nationals due to their unique situation face Foreign National mortgage conditions.
In the United Kingdom, flexible mortgages allow for more freedom by the borrower to skip payments or prepay. Offset mortgages allow deposits to be counted against the mortgage loan. in the UK there is also the endowment mortgage where the borrowers pay interest while the principal is paid with a life insurance policy.
Commercial mortgages typically have different interest rates, risks, and contracts than personal loans. Participation mortgages allow multiple investors to share in a loan. Builders may take out blanket loans which cover several properties at once. Bridge loans may be used as temporary financing pending a longer-term loan. Hard money loans provide financing in exchange for the mortgaging of real estate collateral.
