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Mortgages: Understanding Loan Types
It’s easy to get lost in the fine print. Here’s a list of mortgage loan types, and a brief summary of each to help keep you in the know:

Adjustable-Rate Mortgages (ARM)
With ARM loans, the borrower’s interest rate and monthly payment amount rises and falls according to the index it’s “tied” to. Because these loans start out a percentage point or three below fixed-rate mortgages, they are particular popular when interest rates are high. The best loans put a cap on annual rate increases, limiting the amount your loan rate will raise within a given year to 1 or 2 percentage points, and to 5 percentage points overall for the lifetime of the loan. The most popular arm indexes are those linked to three-month, six-month and one-year Treasury Bills, the 11th District Cost of Funds (COFI), the prime rate and the London Interbank Offer Rate (LIBOR).

Fixed-Rate Mortgages (FRM)
This, the most popular choice of mortgage types, allows the homebuyer to know exactly what they’ll be paying each month for the life of the loan. If interest rates fall, the buyer can always refinance at the lower rate. Lenders are now offering more fixed-rate loan programs that allow for lower down payments (5% down or less,) and other considerations. Adjustable rate loans generally require a larger down payment. The most common fixed-rate loans are for terms of 15 or 30 years. If the borrower can afford the shorter term, it’s a good way to build equity fast and to potentially save tens of thousands of dollars over the life of the loan. Fixed-rate mortgages make the most sense when interest rates are low and when the borrower plans to remain in the home a minimum of seven (7) years.

Graduated-Payment Mortgages
This mortgage type is more of a risky for borrowers, for several reasons. Early payments are so low that they don’t cover the interest due, which results in negative amortization, which means the borrower owes more each month, not less. Monthly payments gradually increase to cover principal and interest, and often the borrower ends up paying more than they would have for a regular (ARM or FRM) mortgage loan. Some GPMs are fixed while others are adjustable. Given the fact that lenders have literally rewritten the rules to get more people into homes today, there is seldom a good reason to choose this loan type.

Intermediate Fixed Mortgages
These are a family of 20- or 30-year loans that are fixed for a set amount of time, such as 5 to 7 years, and then they readjust once for the remainder of the loan. This readjustment is based on a predetermined index. These loans are more commonly known as intermediate fixed loans or extended balloon mortgages. These loans are not for the fainthearted. The borrower enjoys low, fixed payments for 1-7 years, and then the loan readjusts as long as certain conditions are met (such as interest rates haven’t risen more than five percentage points, and the borrower hasn’t made any late payments in the previous 12 months, etc.) If conditions aren’t met, all bets are off, and borrower beware.

If the borrower is a first-time home buyer who plans to trade up before the loan comes due, they might want to consider an intermediate fixed rate loan. Nevertheless, be sure to get all stipulations in writing and review them carefully. (There’s a new family of intermediate loans becoming available that are similar to these other balloon mortgages, but when they become due after 5 to 7 years, they adjust and become variable rate loans. They also do not carry the rigid stipulations that balloon loans carry, making them a little easier to live with if you don’t move before the loan is due.)

Other Loan Types
There are various other loan types, including rollovers, wraparounds, zero-interest-rate mortgages and buy-downs, but the loan types listed above are the most common. If you/your client decide(s) to opt for something more exotic, be sure to read the fine print and consult a mortgage loan specialist to be sure all points of the loan are understood. As always, caveat emptor.
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