Types of mortgage loans

Major types of mortgage loans include:
  • Fixed-rate loans. Because they offer a monthly payment that is known and does not change, fixed-rate mortgage loans remain the most popular type.
    Most fixed-rate mortgages are for loan terms of 15 or 30-years. A 30-year loan has lower payments but a slightly higher interest rate. For all of 2008, the average mortgage rate on a 30-year fixed-rate loan was 6.03%, according to data from Freddie Mac. For 15-year mortgages, the average rate was 5.62%.
    To pay off a fixed-rate loan sooner, check with your lender to make sure you can make prepayments. You should be allowed to make these anytime and for any amount, and at no penalty.
  • Adjustable-rate loans. After an initial term, the interest rate on an adjustable-rate mortgage (ARM) loan is re-set periodically. This is to keep the rate in line with current market interest rates. For example, a 3/1 ARM loan offers a fixed rate for the first three years, adjusting once a year thereafter. A 5/1 ARM loan offers a fixed rate for the first five years, adjusting yearly thereafter. The lender sets the interest rate by adding a margin to an index rate. Common indexes include:
    • Cost of Funds Index. The Eleventh District of the Federal Home Loan Bank Board, which covers California, Nevada and Arizona, publishes the Cost of Funds Index. For more information on the index, visit the Web site of the Federal Home Loan Bank of San Francisco.
    • Treasury bill yields. The yield on the 1-year T-bill, adjusted for a constant-maturity security, is widely used.
    Most ARM loans have a periodic rate cap and lifetime cap to limit the amount the interest rate can increase each adjustment period and over the term of the loan, respectively.
    If you have a payment cap in your loan agreement, you may face negative amortization of your loan. This has the effect of increasing the amount you owe.
  • Convertible mortgage loans. These are ARM loans that allow you to convert to a fixed-rate loan at or before a specified time. The conversion privilege lets you start off with a low variable rate, then lock in when fixed rates drop low enough.
  • Balloon mortgage loans. These loans often have interest-only payments. In this case, you don’t amortize any loan principal and the entire loan amount is due at the end of the loan term. A balloon mortgage allows you to minimize your monthly payments until you refinance the loan. Another advantage is that a larger share of your payment may be eligible for the mortgage interest tax deduction.

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