With all the different types of borrowers and all the unique situations individuals are in, there are also a myriad of mortgage programs available to cater to those needs. True, there may not be enough to serve every financial situation, but the options have expanded tremendously within the past decade. You have most likely heard of some if not all of these types of programs, but it never hurts to learn more about your options.
Adjustable Rate Mortgage (ARM) - This type of program is fixed for an indicated period of time. Once that indicated period of time has expired, the interest rate adjusts to the current mortgage market and continues to adjust every 6 months or every year, depending on your mortgage terms. You can obtain an ARM with interest only payments or fully amortized payments. In other words, you can also choose to go interest only, which requires that only the interest is due on the loan every month, or you can choose to go fully amortized, which requires that the interest and a portion of the principal is due on the loan every month. ARMs generally provides lower interest rates than fixed rates. Why? Because the lender is only required to keep the interest rate for a certain period of time--meaning in 5 years when the interest rate market has increased and your mortgage term has expired, they can keep up with the interest rate changes instead of maintaining the interest rate as they would be required to do with a fixed rate.
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Types of ARMs: 6 Month Fixed or 2, 3, 5, 7, 10 Year Fixed
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Advantages: Lower interest rates, program flexibility, guideline flexibility, lower monthly payments
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Disadvantages: Unstable interest rate after end of mortgage term, no payoff of the loan is built it
Fixed Rate - This type of program is fixed for the entire life of the loan. The interest rate of this particular type of mortgage will not adjust at any time. You can obtain these fixed rates with interest only payments or fully amortized payments. In other words, you can also choose to go interest only, which requires that only the interest is due on the loan every month, or you can choose to go fully amortized, which requires t hat the interest and a portion of the principal is due every month. Fixed rates are generally higher than the other options because the lender must keep the interest rate for as long as you have the mortgage, no matter how the mortgage market adjusts in the mean time.
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Types of fixed rates: 15, 30, 40, 50 Year Fixed
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Advantages: Fixed rate, stability, eventual pay off of loan
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Disadvantages: Higher interest rates, higher monthly payments, less program flexibility
Hybrid Option-ARM - This type of program is one of the newest types of mortgages produced. The idea and creation of this program is based on the concept of property appreciation--properties will appreciate faster than the mortgage balance increases. This program combines the benefits of fixed rates with the benefits of Option-ARMs. Just like traditional Option-ARMs this type of program provides the borrower with four monthly payment choices--1) Minimum payment (generally about 1.000% - 1.500%), 2) Interest only, 3) 15 year fully amortized, and 4) 30 year fully amortized. The 2nd, 3rd, and 4th options will have the same interest rate, which is about 6.000% - 7.000% higher than the minimum payment. If in the case the borower pays the 2nd, 3rd, or 4th choices, the mortgage balance will remain the same. However, when the borrower takes advantage of the 1st option, negative amortization will be the result where the mortgage balance will increase by the amount of interest left unpaid by paying the minimum payment.
This program is a great option for those who can foresee periods of time of financial difficulty. For example: A borrower intends on paying at least the interest only option on the mortgage every month. But the borrower also knows that next year there will be a period of 3 months where he or she will take a pay cut. During those months it would be very helpful to only be required to pay the minimum payment due on the mortgage. In these cases, this program would be very beneficial. However, keep in mind that because of the lender's "generosity" of allowing flexible payment options, the interest rate at which the mortgage will be fixed will be higher than a traditional fixed rate mortgage.
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Types of Hyrbid Option-ARMs: 5 Year Hybrid Option-ARM, 30 Year Hybrid Option-ARM
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Advantages: Lower monthly payment options, fixed interest rate, allows borrower to qualify to buy more house
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Disadvantages: The option of negative amortization, higher interest rates than fixed rates
Option-ARM - This type of program is one of the newer mortgages in the past 5-10 years and holds the most risk for borrowers. The idea and creation of this program is based on the concept of property appreciation--properties will appreciate faster than the mortgage balance increases. This program provides borrowers with four monthly payment choices--1) Minimum payment (generally about 1.000% - 1.500%), 2) Interest only, 3) 15 year fully amortized, and 4) 30 year fully amortized. The 2nd, 3rd, and 4th options will have the same interest rate, which is about 6.000% - 7.000% higher than the minimum payment. If in the case the borower pays the 2nd, 3rd, or 4th choices, the mortgage balance will remain the same. However, when the borrower takes advantage of the 1st option, negative amortization will be the result where the mortgage balance will increase by the amount of interest left unpaid by paying the minimum payment.
The interest rate for the interest only and fully amortized options are not fixed, so the interest rate for this particular program is essentially adjustable from month-to-month. We strongly recommend against this program unless there is a need for it or it just makes financial sense. For example, if you are purchasing a rental property that you know you can renovate and sell within a few month's time for a higher price, this program may be the way to go. However, if you are buying your home to live in for the next few years or longer, this program is going to be very detrimental. This program is extremely complicated and detailed, to better understand this option you can read our article: "Nightmare Mortgages." To best understand this program and to ask any questions you may have regarding this program, contact one of our mortgage consultants for answers.
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Advantages: Lower monthly payments, allows borrower to qualify to buy more house
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Disadvantages: Negative amortization, interest rate fluctuations
Reverse Mortgage - This type of program has gained popularity in the past few years due to the rising rate of seniors unable to support their retirement. This program has been around for decades and has been available to borowers for a very long time, however it has always been frowned upon due to the way it works. This program works how it sounds--if you reverse the borrower and the lender, what do you get? The lender makes monthly payments to the borrower. The lender is essentially paying off a "mortgage" to eventually own the home. The reason this mortgage option is geared towards seniors is because this program requires a substantial amount of equity. Every monthly payment the lender gives to the borrower comes from the equity of the property. As the years continue, the equity in the house gradually decreases until there is no equity left. At this point in time, the lender now owns the property.
