Different Types of Mortgage Loans Available For First Time Buyers
Thirty years ago, there was only one type of home mortgage loan a buyer could get. Today’s market is teaming with new options for financing a home. Keep in mind that the Mortgage Company, realtor, and mortgage brokers do not necessarily have your best interest at heart. Their job is to sell you a home as quickly as possible. That is where their income comes from.
Should you get your financing through a mortgage broker or go directly to a bank or other lenders?
Mortgage brokers (MBs) are a middle man between the borrower and the lender. They can shop around for the lender with the lowest rates, and find lenders who will offer the best terms for a given credit situation.
For some, it is a good idea to go through a mortgage broker. For those with credit problems, they can often find better financing terms than the consumer could alone.
If you do go through a mortgage broker, ask that they disclose their fees up front. There are actually two types of mortgage brokers, and understanding the difference between them will help you locate a reputable one.
An Up-front Mortgage Broker (UMB) discloses their fees to customers in advance and in writing, and discloses the wholesale prices (rates and points) passed through from lenders. Customers of UMBs pay the broker’s fee plus wholesale loan prices.
A Conventional Mortgage Broker (MB) quotes a retail price to the customer, and usually only reveals their markup in required disclosures after the application process.
What are points and how do they affect my mortgage?
Points are a type of fee paid by the consumer to the mortgage lender. Each point is 1% of the value of the mortgage. For example, on a $150,000 mortgage, one point would equal $1500 paid at closing to the lender. There are actually two types of points. Origination points are used by lenders to recover the cost of the loan origination (processing of the loan).
Discount points are used to “buy” a lower interest rate (also known as a “buy down”). A general rule of thumb is that 1 point on a fixed rate mortgage will buy the interest rate down by .25%, and on an adjustable rate mortgage by .375%. Points can generally be negotiated with the lender.
It is an important consideration as you begin to draw up a strategy in the purchase of your home. Do you want to pay a higher closing cost in exchange for better terms on your mortgage?
This would depend on several factors. First, how much cash do you have available? Another consideration is the length of time you plan on staying in your home before selling.
30 Year Mortgage Loan Example:
Let’s take a hypothetical couple, Bob and Kathy, who are planning to buy their first home. They know they will be staying there for about five years before selling and buying a bigger home.
Their mortgage lender is offering them an $80,000 thirty-year fixed rate mortgage at 6.75%, with no points. This will place their monthly payment at $518.88. If, however, they take two “buy down” points on the loan, their interest rate will be 6.25% with a monthly payment of 492.57. This will save them $26.31 per month, or $1578.60 over the five years they plan on staying in the house.
HOWEVER, two points on this mortgage will cost them $1600 at closing, a little more than they would actually save. Bob and Kathy figure out rather quickly that they are better off not taking the discount points.
Let’s take another couple, on the other hand, who know they will be staying in the same home for the thirty year life of the mortgage.
The lower interest rate would save this couple $9471.60. It would make a lot more sense for this couple to take the $1600 “buy down” at closing. You can see why points are an important consideration when taking out a mortgage.
What are the different type of mortgage loans ?
Now let’s look at some different types of mortgages.
Fixed-Rate Mortgage Loan (FRM):
Very simply, this is a mortgage with an interest rate which is fixed through the life of the loan. The interest rate is set at closing and will never change.
Adjustable Rate Mortgage Loan (ARM):
With this type of mortgage your payments will vary over time. Typically, there is an initial period of time after closing in which the interest rate is fixed (1 year, 2 years, 3 years, etc.), and then there is an incremental adjustment made every so often.
How often the interest rate can change on an ARM, and by how much each time, is determined in the mortgage contract at closing. This will usually be every 6 months or a year, and the amount of each adjustment is tied to an index specified in the mortgage contract. There are a few circumstances in which it is advantageous to get an ARM over a fixed-rate mortgage.
If interest rates are high and expected to drop over time, your payments will probably drop with each adjustment. If you are planning to live in the home for a short length of time, your initial fixed rate period may be lower than what you would get with a straight fixed-rate. Do your research and shop around for the best mortgage.
Balloon Mortgage Loan:
A balloon mortgage is one which becomes due in full at a predetermined time, usually 5, 10, or 15 years. It is set up like a traditional 30-year fixed -rate mortgage, usually has a lower interest rate, but when the loan comes to term the outstanding balance must be paid in full. With proper planning this can be done either by refinancing or selling the home.
80/20 Mortgage Loan:
This strategy is offered by many lenders as an option to finance the home with no money down. It entails taking out two mortgages on the home, a primary (80% of the financing) and a secondary mortgage (the remaining 20%). Often the second mortgage is offered as a balloon mortgage and it usually has a higher interest rate than the primary.
Advantages to the consumer are that no down payment is required (just closing costs), and this strategy keeps the purchaser from having to pay PMI (Private Mortgage Insurance).
PMI is required on all mortgages in which 20% equity is not owned in the home. It is added into the mortgage payment each month. With the 80/20, since 20% is financed separately, the consumer can get around having to pay this. The downside of the 80/20 is that there is no equity in the home.
Interest Only Mortgage Loan:
This type of mortgage allows you to pay interest only (without paying down the principal) for a fixed length of time, usually 5 to 10 years. It is usually financed at a slightly higher interest rate than a standard mortgage.
It is an option to consider for some who have a variable income and who are disciplined enough to make payments on the principal when they can. It may also be considered by some who plan to remain in a home for only a few years and expect the housing market to rise in that area over that period of time.
This is a risky mortgage and is not for everyone. After the interest only period is over, the unpaid principal is added into the monthly payments over the rest of the life of the mortgage. This makes the mortgage payment much higher at that time than a conventional mortgage would have been, unless principal was paid during the initial phase.