Basic Types of Mortgage Loans and Terms
While several mortgage products come with different or unique features, most loans fall under a few standard types. It is important to understand these differences, especially when determining the right fit for your needs since they will affect your current and long-term payments.
Basic Types of Mortgage Loans
A fixed-rate mortgage offers a consistent interest rate for the entire life of the loan, which means that your total monthly payment of principal and interest will remain the same over time. If you plan to stay for a long time in the home you’re buying, or want a consistent mortgage payment amount, a fixed-rate mortgage is usually the way to go. Fixed-rate mortgages are available for various durations—e.g., 10, 15, 20, or 30 years. Loans with longer terms usually have a lower monthly payment, but a higher overall repayment amount, because you’re paying interest on the amount borrowed over a longer period of time.
If you get an adjustable-rate mortgage (ARM), the interest rate can change—and most likely will—over the life of your loan. Depending on your loan terms, your interest rate could remain unchanged for the first adjustment date, such as 3, 5, or 7 years. Then, it could change as often as every six months throughout the rest of the 30-year period. While an adjustable-rate mortgage may start off with a lower interest rate, it could increase, which can increase your payments. Borrowers may choose to go with an ARM when they don’t plan on staying in a home long-term, or if they expect their incomes to increase in the next few years.
An interest-only mortgage has an initial period of time at which your payments only cover the cost of interest, and they don’t go toward the principal amount you owe. Additionally, initial rates are often lower than fixed-rate mortgages. Usually, this can mean that your payments are smaller in the beginning, and then at the end of the interest-only period, they increase significantly to include both interest and principal payments. Some may even require a balloon payment for the entire balance. Interest-only mortgages are less common, and they can add risk because borrowers need to be prepared for the higher payments after the interest-only period ends.
|Interest-only mortgages can come with a certain amount of risk. |
For example, interest-only loans can be used as a wealth management tool yet may carry a high level of risk.
They can be incorrectly used to help qualify a homebuyer who would not otherwise be able to qualify, such as, when the lower interest-only payment is used to lower a homebuyer’s debt-to-income (DTI) ratio.
There are several types of government-guaranteed loans available with unique benefits and additional flexibilities around credit and income guidelines that could help you purchase a home. Usually, you will have a lower down payment and qualifying guidelines that are more flexible than what you might be eligible for with a private lender. Make sure to let your lender know if you think you qualify for these loan types:
- Federal Housing Administration (FHA) if you have income restrictions,
- Department of Veteran’s Affairs (VA) if you currently serve in the military, or are a military veteran,
- United States Department of Agriculture (USDA) 502 direct or guaranteed loans if you live in a rural area, or
- United States Department of Housing and Urban Development (HUD) Section 184 and 184a loans if you are American Indian, Alaska Native, or Native Hawaiian.
Predatory Lending Practices and Products and How To Avoid Them
You can probably tell just by the name that steering clear of predatory lending is a good idea, but you may not know what it means, or what to look for to avoid it. So, let’s start with the basics.
What is predatory lending?
Predatory lending can cover a number of different practices, but generally it refers to lenders that offer high-risk loans which may include inflated fees, higher rates, or other terms that increase costs to the borrower. Some of these are easy to spot, but others can be more complicated. Here are a few specific examples to watch out for:
Usually when you make your monthly payments, they cover the interest you’ve accrued that month plus some of the principal, or the amount you paid for the home. Every month the amount you owe on the home goes down.
In a loan with negative amortization though, monthly payments are so low that they don’t even cover interest. That means instead of the amount you owe shrinking every month, it grows. This can leave you with less equity or worse, in a situation where you owe more than the home is worth.
You can check for this tactic by asking for an amortization schedule for the loan. If the principal dollar amount doesn’t decline every month, that’s a sign you should look elsewhere for financing.
Some lenders may steer homebuyers towards higher cost products than they qualify for in exchange for a kickback from other stakeholders, including high-cost insurance policies that are added into closing costs. This can be hard to spot if you’re new to homebuying and don’t know what to expect, which is why it’s important to do your research.
The best way to avoid these pitfalls, and any other unscrupulous practices, is to shop around. Many of these practices will stand out if you compare multiple offers. Always compare interest rates, lender fees, and prepayment penalties, which may require you to pay additional fees when refinancing or selling your home.
Understand the length of the loan and how this affects your mortgage payment amount, and what is included in the monthly payment to determine the best loan option. Comparing offers will help you recognize any loans that are high risk and potentially predatory.
Ask Questions and Take Time To Review
Your lender should provide you all of the necessary documents for review prior to closing. Ask questions during the process to alleviate any confusion or last minute concerns during closing. You should always feel comfortable asking questions and requesting copies of documents to read carefully and to have reviewed by a lawyer or a HUD-certified housing counselor. If the lender pressures you to sign or is hesitant to allow time to have the documents reviewed, they are likely hiding details of the loan.
Review all aspects of the mortgage documents and make sure there are no blank areas that could be used to alter the loan agreement. A best practice is to escrow taxes and insurance and have them included in the monthly mortgage payment, so be sure to look for that information in the loan documents. Some predatory products may leave out these costs in order to quote a much lower monthly payment and then add them in later. Finally, if you do not feel comfortable with the loan details or are not given answers to any questions, don’t hesitate to choose a different lender.
Whether you have limited cash savings for a down payment, want to buy a fixer-upper, or decide that a manufactured home is the way to go, it’s important to know that some conventional mortgage products also apply to these situations. Conventional mortgages can also be low down payment loans, like 3%, 5%, 10% and other down payment options with conventional loans. Conventional loans of fixe-uppers that need renovation work or repairs. Renovation conventional loans can fund the purchase and the renovation of the home. Conventional loans can be used for non warrantable condos and townhomes; and also manufactured housing loans when Government guaranteed loans won’t.
Basic Mortgage Terms
Many mortgage-related terms may be confusing, especially as you start talking to lenders. Knowing some of these terms ahead of time can make you feel more at ease throughout the process, more confident asking questions, and more comfortable comparing options.
Annual Percentage Rate
An annual percentage rate (APR) is an even “bigger picture” view of the total cost of borrowing money and can be useful when comparing mortgages that look similar. It reflects many, but not all, of your costs as an annualized rate. It can include the interest rate, points, mortgage broker fees, and closing costs, as well as other fees you may pay for the loan. Since these costs are included in your APR, your APR is typically higher than your interest rate. Two lenders could be charging the same interest rate, but the lender that is charging more for other fees will have the higher APR. That’s why it’s always important when comparing lenders to look at the APRs quoted and not just the interest rate.
Points come in two forms: origination points and discount points.
Origination points are applied toward costs that lenders incur for processing, underwriting, and approving your loan. These points can be a percentage of the loan amount or a flat fee. Keep in mind, if you include your closing costs in your loan, you will be paying interest on those costs over the life of the loan.
On the other hand, mortgage discount points are purchased to lower the mortgage interest rate. The cost of a point is usually calculated in relation to your loan amount; typically, one point equals one percent of your loan amount. For example, if your mortgage amount is going to be $125,000, then one point would equal $1,250. If you are considering applying points to your loan, be sure to talk to your lender to determine if it is the right approach.
Amortizing a loan means paying it off in regular installments over a period of time. With each installment, a percentage of that amount goes toward paying off your principal and the rest toward interest. Your lender will most likely create an amortization schedule that shows how much of each payment goes toward the principal and how much goes toward interest. Typically, more goes toward interest in the beginning, with less money going toward the principal. Then, eventually, as the balance goes down more of your payment will go toward paying off the principal and less toward interest.
Private Mortgage Insurance
If your down payment is less than 20% of the home purchase price, you may need to get mortgage insurance. Mortgage insurance protects the lender in case you stop paying your home loan, and it’s typically paid along with your monthly mortgage payment. If you fail to make payments, even with mortgage insurance, your credit score could suffer, and you could lose your home to foreclosure. While it’s an additional cost, it may help you get a mortgage with a lower down payment. Depending on the terms of your loan and mortgage insurance, some loans allow you to cancel the insurance once you’ve reached 20% equity, which could mean extra savings down the line.
Your monthly mortgage payment is typically made up of four components: principal, interest, taxes, and insurance. The principal is the money you borrowed, or the amount financed. The interest is what the lender charges you to borrow the money used to purchase the home. Taxes are what you pay in property taxes to your local city/municipality and sometimes county. Insurance is what you pay to insure your home from damages, such as fire or natural disasters. For conventional loans, depending on your loan terms, if you put less than 20% down, then mortgage insurance (MI) will also be included in your monthly payment until you reach the 20% equity threshold. If your loan requires MI then you’ll want to pay attention to the equity in your house to know when you’ve reached that 20% loan-to-value threshold so you can ask to cancel the MI payment.
Many lenders help borrowers to set up a separate escrow account to pay for estimated taxes and insurance. This alleviates borrowers from having to remember to pay their real estate taxes and homeowner insurance premiums. Since the amount is estimated, borrowers may be billed if there is a shortage. This amount will normally adjust through the life of the loan.
This glossary contains common terms often used in the homebuying process and their definitions.
More First Time Home Buyer Info:
+ Rent or Buy.
+ Shopping with a Lone Star Luxury Agent.
+ Finding a Lender.
+ Understanding Debt.
+ Credit Score.
+ Things To Consider Before Buying.
+ Understanding the Mortgage Loan Process.
+ Looking at Types of Homes.
+ Submit a Home Offer, Get an Inspection.
+ Closing your Loan.
+ Welcome to Homeownership.