Discover the best home loan for you.Creating the right mortgage begins with choosing the best loan for you. Michelle Oddo and her team will diligently walk you through the options:
Fixed Rate Mortgages
As the most common home loan option, the traditional fixed-rate mortgage loan includes monthly principal and interest payments. Because the payments never change during the loan’s lifetime, home buyers find this an appealing option.
More about Fixed Rate Mortgages
With terms ranging from 10 to 30 years, the loan can be paid off any time without penalty. This type of mortgage is structured (known as “amortized”) that you can completely pay off by the loan’s term end. Also there are “bi-weekly” mortgages, which shortens the loan’s term as you pay half of the monthly payment every two weeks (with 52 weeks each year, you’ll make 26 payments, or 13 “months” worth annually).
If you choose an “impound account,” your monthly payments may vary. If you put less than 20% cash down, then in addition to your monthly loan payment, some lenders will collect additional money for the prorated cost of property taxes and homeowners insurance. This allows the lender to pay these expenses. If the property tax or the insurance change, your monthly payment will be adjusted. Overall though, payments in a fixed rate mortgage are very stable and consistent.
Adjustable Rate Mortgages (ARM)
During this loan’s term, the included interest payments will adjust, depending on current market conditions. Adjustable-rate mortgages typically carry a fixed-interest rate for a set period of time before the shift occurs.
More about Adjustable Rate Mortgages
ARM’s initial rates are lower than fixed rate mortgages, allowing you to afford and purchase a more expensive home. Adjustable rate mortgages are usually structured over a 30 year term where the initial rate is fixed for from 30 days to 10 years. ARM loans have a “margin” and an “index.” Margins on home loans vary from 1.75 – 3.5%, depending on the index and the borrowed amount (in relation to the property value). The index is the instrument the ARM loan is tied to (for example: 1-Year Treasury Security, London Interbank Offered Rate, Prime, 6-Month Certificate of Deposit and the 11th District Cost of Funds).
When the ARM adjusts, the margin is added to the index (typically rounded to the one-eighth of 1% for the new interest rate). The new rate is then fixed for the next period. This adjustment occurs yearly, but there are factors which limit how the rates can change (known as “caps”).
For example a “3/1 ARM” can have a 2% initial cap, a 6% lifetime cap and initial interest rate of 6.25%. In the fourth year the highest rate could be 8.25% and during the lifetime the highest rate would be 12.25%.
ARM loans sometimes have a conversion feature, allowing you to convert from an adjustable to a fixed rate loan. There’s a minimal conversion charge; however, the conversion rate is normally a little higher than the market rate the lender could provide at that time by refinancing.
Hybrid ARMs (3/1 ARM, 5/1 ARM, 7/1 ARM, 10/1 ARM)
Combining features from both fixed-rate and adjustable rate mortgages, hybrid ARM mortgages can be another excellent option for a home loan. They’re also known as fixed-period ARMs.
More about Hybrid ARMs
A hybrid loan starts with a fixed interest rate for usually 3, 5, 7 or 10 years. The loan then converts to an ARM for a set term of years. Such as a 30-year hybrid with a seven-year fixed rate and a 23-year adjustable rate.
A fixed-period ARM’s initial interest rate is lower than the rate of a 30-year fixed mortgage (sometimes significantly less). So you can enjoy a lower rate while having period of stable payments. On the other hand a typical one-year ARM goes to a new rate annually. While an ARM’s starting rate is considerably lower than a standard mortgage, they risk future hikes.
Homeowners can get a hybrid and refinance when the initial term expires. These loan types are best for people not planning to stay long term in their homes. By getting a lower rate and monthly payments than with a 30- or 15-year loan, they can break even more quickly on refinancing costs like title insurance and appraisal fees. With lower monthly payments, borrowers can make extra payments to complete the loan early and saving them thousands of dollars.
HARP 2.0 Refinance
For homeowners who are “underwater” (meaning they owe more than their home is worth), HARP 2.0 is a refinance option to consider.
More about HARP 2.0 Refinance
To be eligible for a HARP 2.0 refinance, you must meet the program’s certain criteria:
1) You haven’t refinanced through the original HARP program.
2) You’re current on mortgage payments and no late payments over 30 days due (for 6 months) and no more than one late payment in the last 12 months.
3) Your mortgage is backed by Fannie Mae or Freddie Mac and was bought before May 31st, 2009.
4) Your loan to value (LTV %) is at least 80%.
The HARP allows homeowners who owe a mortgage that’s more than the value of their home a more affordable and stable loan.
Mortgages insured by the Federal Housing Administration (FHA) allow borrowers to receive low mortgage rates with a minimal down payment.
More about FHA Loans
Single family and multifamily homes can qualify for an FHA loan. Banks can continuously issue FHA loans without much risk or capital requirements. The FHA doesn’t issue loans or set interest rates, just guarantee against default.
Individuals who may not qualify for a conventional mortgage may obtain an FHA loan. They’re a popular option for first time home buyers. FHA loans offer low minimum down payments, reasonable credit expectations and flexible income requirements.
Mortgages guaranteed by the Department of Veteran Affairs offers military veterans exceptional benefits! VA loans include low interest rates and no down payment is required. This program helps military veterans fulfill their dream of home ownership.
More about VA Loans
Military personal that have served 181 days during peacetime, 90 days during war, or a spouse of serviceman either killed or missing in action can qualify for a VA loan.
Since a VA mortgage is guaranteed, lenders offer lower interest rate and terms than a conventional home loan. Available in all 50 states, the loan also has reduced closing costs and zero prepayment penalties. Actually in the case the loan defaults, the Veterans Administration provides lenders insurance. Additionally veterans may be offered services to avoid defaulting on their loans.
Interest Only Mortgages
Interest only mortgages allow borrowers to make monthly payments solely toward the loan’s accruing interest (rather than the principle) for a specified period of time.
More about Interest Only Mortgages
For a certain period of time “Interest Only” mortgages have monthly payments which don’t include the repayment of principal. Interest Only loans can be an option on fixed rate, adjustable rate mortgages and ARMs. When the interest only period ends, the loan is fully amortized, so monthly payments increase greatly (larger than if it’d been fully amortized from the beginning). The longer the period of interest only payments, the larger the new monthly cost.
Interest-only terms won’t build equity, but could help you close on a more expensive home.
People in interest only home loans are likely to refinance before the term expires. It can be an effective way to lease your dream home now. Then you can invest the principal portion of your payment elsewhere (and get the tax and appreciation benefits of being a homeowner).
Beware with interest only loans. The payments could save you money in the short-run, but cost you more over the 30-year term. However most borrowers repay their mortgages within 30 years.
Borrowers with infrequent income can benefit from interest-only mortgages. They can make interest-only payments during lean times and use bonuses and such to pay down the principal.
Components of Adjustable Rate Mortgages
To make an informed decision about your home loan, we’ll let you know the benefits and risks of adjustable-rate mortgages. There are a number of working components.
List of Components of Adjustable Rate Mortgages
Index: A tool showing the rise and fall, primarily based on economic fluctuations. It’s usually an indicator and the basis of future interest adjustments for all loans. Lenders use a variety of indexes.
Margin: Referring to the lender’s loan cost of doing business plus profit, it is included in the interest rate (along with the index).
Initial Interest: The initial rate of the loan period is sometimes lower than the note rate.
Note Rate: A particular loan’s actual interest rate.
Adjustment Period: The scheduled interval when the interest will change during the life of the loan (e.g. annually).
Interest Rate Caps: Limits placed at the top-and-bottom movement of an interest rate for a specific period and lifetime adjustment (e.g. a cap of 2 and 6, meaning a maximum 2% interest increase per adjustment with a maximum 6% interest increase over the loan’s term).
Negative Amortization: When a payment insufficiently covers the loan’s interest. So the shortfall amount is added back on the principal’s balance.
Convertibility: The ability to change from an ARM to a fixed-rate loan. A fee may be charged for the conversion.
Carryover: The interest rate increases in excess of the amount allowed by the caps. It can be applied to later interest rate adjustments (a component most new ARMs are deleting).
Commonly Used Indexes for ARMs
Lenders use indexes which affect ARM mortgage rates. Click to see the list of the most common indexes.
List of Commonly Used Indexes for ARMs
6-Month CD Rate Index
For 6-month negotiable Certificates of Deposit, this index is the weekly average of secondary market interest rates. So for a 6 month CD indexed ARM loan, the rate is typically adjusted every 6 months. Weekly index changes can be volatile.
1-year T-Bill Index
For U.S. Treasury securities adjusted to a regular maturity of one year, this index is used for the weekly average yield. It is also applied to the majority of ARM loans. So the interest rate for these loans is subject to change every year. For those who’d like to take advantage of a low interest rate, but would like a longer introductory period, additional Hybrid ARM loan programs are available. The 3/1, 5/1, 7/1 and 10/1 ARM loans have a fixed interest rate for 3, 5, 7 and 10 years before beginning yearly adjustments. These programs typically don’t have introductory rates as low as the one year ARM loan; however, they are lower than the 30-year fixed mortgage loan’s rate. Like the 6-month CD rate, weekly index changes can be volatile.
3-year & 5-year T-Note Indexes
These indexes track the weekly average yield on U.S. Treasury securities which are adjusted to a constant maturity for 3 or 5 years (and on 3/3 or 5/5 ARM loans). So the interest rate adjusts every 3 or 5 years on such loans. These loan program are good for borrowers preferring fewer interest rate adjustments. The index changes on a weekly basis and can also be volatile.
The prime rate is what banks charge for loans to their most credit-worthy customers. As reported by the Federal Reserve, the prime rate is charged by most large banks. So when applying for a home equity loan, ask if the lender will use its own prime rate, or the Federal Reserve / Wall Street Journal’s prime rates. When the Federal Reserve makes changes to the Federal Funds and Discount Rates, this index usually shifts. This rate can become volatile (or not move for months) depending on economic conditions.
12 Moving Average of 1-year T-Bill Index
This is the 12 month moving average of the average monthly yield on U.S. Treasury securities which are adjusted to a constant maturity of one year. Sometimes this index is used for ARM loans in lieu of the 1 year Treasury Constant Maturity (TCM) rate. Because this index is a 12 month moving average, it’s less volatile than the one year TCM rate (changing on a monthly basis).
Cost of Funds Index (COFI) – National Index
This index shows the monthly median cost of funds for interest (dividends) paid or accrued on deposits, Federal Home Loan Bank (FHLB) advances and other borrowed money during a month (as a percent of balances of deposits and borrowings at month end). The interest rate on COFI (Cost of Funds Index) indexed ARM loans is typically adjusted every 6 months. Index change monthly and are not very volatile.
Cost of Funds Index (COFI) – 11th District Index
This index rate is used for the weighted-average interest rate paid for savings and checking accounts by 11th Federal Home Loan Bank District savings institutions, FHLB advances and other fund sources. The 11th District represents the savings institutions (savings & loan associations and banks) headquartered in Arizona, California and Nevada. Since the largest part of the COFI is interest paid on savings accounts, this index records market interest rates in both upward and downward trends. So ARMs’ rates which are tied to this index rise and fall more slowly than most, which is good option if rates are rising (but not if rates are falling).
The London Interbank Offered Rate (LIBOR) indexes interest rates which banks charge each other for overseas deposits of United States dollars. These rates are available in one, three, six and twelve month terms. The index and the source varies among lenders. Common sources are the Wall Street Journal and Fannie Mae. The interest rate on many LIBOR indexed ARM loans adjusts every 6 months. The LIBOR index changes daily or weekly and can become extremely volatile.
National Average Contract Mortgage Rate (NACR) Index
This index is used for the national average contract mortgage rate by combined lenders for purchasing previously occupied homes. This index changes monthly and is not very volatile.
Balloon mortgages include a note rate which remains initially fixed and at the end of the mortgage term, the principal balance becomes due.
More about Balloon Mortgages
Because the remaining principal balance is due at the end of the period, so you can choose to either refinance or pay off the loan. There are no penalties to pay off the loan before it’s due. You may refinance anytime during the loan’s life.
Usually these loans have 5 or 7-year terms. For example, a seven year balloon mortgage with a 7.5% interest rate would feature this rate for the loan’s entire term. After seven years, the remaining balance would be due.
Reverse Mortgages allow senior homeowners to convert a portion of their home equity into cash while still living in the home.
More about Reverse Mortgages
A reverse mortgage is a home equity loan which allows you to convert part of the existing equity in your home into cash (while you still retain ownership of the property). Equity is the current cash value of a home, subtracting the current loan balance.
Working much like a traditional mortgage but reversed as the lender pays the homeowner. As the homeowner continues living in the home, no repayment is required. The funds received from the lender may be used for anything such as housing expenses, taxes, insurance, fuel or maintenance costs.
You could receive the funds in one sum, monthly payments, a line-of-credit or a combination of the three (depending on the lender and reverse mortgage program). The amount you’re eligible to borrow depends on your age, the home’s equity and the interest rate set by the lender.
Because you retain ownership of the home, you’re still responsible for taxes, repairs and maintenance.
Depending on the reverse mortgage plan, the repayment is due with interest when the homeowner permanently moves, sells the home, dies, or the pre-selected loan term has ended. The lender doesn’t take ownership of the home if the homeowner passes away. Instead the heirs must pay off the loan, usually by refinancing the loan into a forward mortgage (if they meet eligibility requirements) or by with the proceeds generated by the property sale.
Graduated Payment Mortgages
Another option to consider are Graduated Payment Mortgages. Payments on these loans increase annually for a set period of time (e.g. 5 or 10 years). Mortgages then become fixed for the remainder of the loan.
More about Graduated Payment Mortgages
When interest rates are high, using a graduated payment mortgage can increase your chances of qualifying for the loan, because the initial payment is less. The disadvantage is a smaller initial payment causes the interest owed to increase, plus the payment shortfall from the initial years of the loan is added on to the loan. So there’s potential for a “negative amortization” situation (when the payment is less than the interest charged over that period, resulting in an increase in the outstanding loan balance).
What kind of home loan program is best for you?
It’s easy to feel overwhelmed by the many different types of home loans. There are many loan options built to meet home buyers’ unique needs (and no one correct answer). Choosing a type is an important decision that takes time and research. Exploring your options can save you thousands of dollars in the long run.
Questions to help determine what home loan type is best for you:
- Will your financial situation change over the next few years?
- Will you live in your current home for a long time?
- Will you feel comfortable with changing the mortgage amount?
- Will you want to be free of mortgage debt before your children go to college or you retire?
The general guidelines below can help you get started:
|How long you plan to stay in your home.||Plan(s) to Consider|
|1-3 years||3/1 ARM or 1-year ARM|
|3-5 years||5/1 ARM|
|5-7 years||7/1 ARM|
|7-10 years||10/1 ARM or 30-year fixed|
|10+ years||30-year fixed or 15-year fixed|