Mortgages 101: Know Your Options

As if applying for a mortgage wasn’t complicated enough, the number of mortgage loan options available to buyers can be overwhelming. As you are preparing to apply for your loan, your financial advisor and lending officer will be able to help you determine which type of mortgage is best for you. However, knowing as much as possible about the many different types of loan options ahead of time can help you make a more informed decision. Below are some of the most popular options:

Fixed Rate Mortgage (FRM)

The most common type of home loan is the Fixed Rate Mortgage. With a Fixed Rate loan, the interest rate remains the same throughout the entire life of the loan. These loans are most frequently available in 10-, 15- and 30-year options.

The principal benefit of Fixed Rate Mortgages is predictability. FRMs allow buyers to know exactly how much their monthly payments will be throughout the course of the loan. This is why they’re so popular; the security that comes along with that knowledge can be invaluable, no matter where you are in your career, as it allows for more effective long-term budgeting.

Even if you acquire an FRM during a period in which interest rates are high, you will still have an opportunity to refinance in the future. So, if you’re mostly risk-averse, locking in a Fixed Rate will always be in your best interest.

Adjustable Rate Mortgage (ARM)

Unlike Fixed Rate loans, Adjustable Rate Mortgages (ARMs) offer fluctuating interest rates after a predefined period. That predefined period can vary substantially, but here are some of the most common permutations:

• One Year – Interest rates remain the same for the first year, then adjust for market conditions every year thereafter.
• 3/1 – Interest rates remain the same for the first three years, then adjust for market conditions every year thereafter.
• 3/3 – Interest rates remain the same for the first three years, then adjust for market conditions every three years thereafter.
• 5/1 – Interest rates remain the same for the first five years, then adjust for market conditions every year thereafter.
• 5/5 – Interest rates remain the same for the first five years, then adjust for market conditions every five years thereafter.
• 7/1 – Interest rates remain the same for the first seven years, then adjust for market conditions every year thereafter.
• 10/1 – Interest rates remain the same for the first 10 years, then adjust for market conditions every year thereafter.
• 5/25 – Interest rates remain the same for the first five years, then adjusts once for market conditions.

Adjustable Rate Mortgages offer a couple of benefits over Fixed Rate options. The first, and perhaps most appealing, is the reduced interest rates available with an ARM. When considering an ARM, know that the more often the loan adjusts, the lower your initial interest rate will be. After that initial period, however, interest rates will be subject to reevaluation based on current market status.

This can be particularly helpful if you’re planning on buying, but might only live in the property for a short time. Then you have all the benefits of the lower interest rate for the initial period, but are less likely to deal with increased rates down the road.

If, however, you’re wary of current (at the time of application) high interest rates, and are unsure of your ability to refinance in the future, a one-time adjustment, like that offered by a 5/25 ARM, might be ideal. In that situation, you only have to deal with one adjustment through the course of the loan.

Balloon Mortgage

Balloon Mortgages typically operate as Fixed Rate loans with a finite payment period ending in an immediate due date of the value of the loan. These types of loans are mostly reserved for buyers who are selling a property or receiving a substantial sum of money before the final due date. They often feature low monthly payments and interest rates because of the short-term nature of the loan.

However, these loans can be quite dangerous for those buyers who run into problems securing expected monies before the due date. In the event that the buyer cannot pay the final balance within the predefined period, the loan defaults and the home goes into foreclosure.

Conforming vs. Jumbo Loans

The difference between Jumbo and Conforming Mortgages is largely one of dollar value. Both designations refer to the loan’s relation to Fannie Mae and Freddie Mac GSE (Government Sponsored Enterprise) loan guidelines. These guidelines establish maximum ranges for what are considered normal, or Conforming, loans. Anything outside of those parameters is considered non-conforming, and is then subject to different stipulations.

Here, a Jumbo Mortgage refers to those loans that exceed the maximum dollar value established for conforming loans in that year. While these are often considered to be reserved for luxury properties, the Conforming maximum is frequently low enough to exclude even modest homes in highly desirable locations.

Jumbo Mortgages often present a higher degree of risk for the lending agent, as a defaulted Jumbo loan is usually attached to a costly property that may be more difficult to move. For that reason, they often have higher interest rates leading to larger monthly payments.

Private Mortgage Insurance

Mortgage Insurance offers lenders a way to ensure payment in the event of a buyer-defaulted loan. Lenders most often require the purchase of Mortgage Insurance when the applicant is putting less than 20% down on the home purchase. In these situations, buyers will usually need to seek out Private Mortgage Insurance (PMI). In most cases, that buyer will need to carry the PMI until the remaining value of the loan divided by the value of the home reaches less than 80%. Premium rates can vary, but frequently average around $50-100 monthly per $100,000 dollars borrowed.