A mortgage is a long-term loan that uses real estate as collateral. A
mortgage is usually used for buying a home. Mortgage loans are usually fully
amortizing, which means that the monthly principal and interest payment will pay
off the loan in the number of payments predetermined on the note. Mortgage loans
are also portrayed by the length of time for repayment, such as 15 or 30 years,
and whether the interest rate is adjustable or fixed. Mortgage loans where the
down payment is less than 20 percent typically requires private mortgage
insurance (PMI), government insurance, or guarantee.
Most mortgage loans entail monthly payments of principal and interest, plus
additional payments that are set aside in escrow accounts to pay property taxes
and homeowners insurance. Also, loans with PMI or government mortgage insurance
may require payment of a monthly mortgage insurance premium as part of the
regular monthly payment.
Some lenders offer bi-weekly mortgages, which call for only 26 payments per
year. The details of bi-weekly mortgages can differ, so it's best to ask the
lender to outline the particulars of how these programs work.
Homebuyers who can afford the higher monthly payment sometimes favor a 15-year
mortgage to a 30-year mortgage. Interest rates on 15-year mortgages generally
are slightly lower than 30-year rates. Also, a homebuyer financing a home
purchase with a 15-year mortgage will repay principal significantly faster and
will pay far less total interest over the term of the loan.
Conventional Mortgages
A conventional mortgage is one that is not guaranteed or insured by the
government. Conventional loans with a down payment of less than 20 percent
typically require private mortgage insurance (PMI), which protects the lender if
the homeowner defaults on the loan.
FHA-Insured Loans
The Federal Housing Administration (FHA), which is a part of the US Department
of Housing & Urban Development (HUD), runs several low down payment mortgage
insurance programs that buyers can use to purchase a home. FHA-insured loans
generally require the buyer to make a three percent cash contribution to the
down payment and closing costs. FHA-insured loans are available from most of the
same lenders who offer conventional loans. The maximum FHA-insured loan amount
for a one-family home ranges from about $160,176 to $290,310 depending on local
area median home prices and other factors.
Rural Housing Service Loans
The Rural Housing Service (RHS), which is a part of the US Department of
Agriculture, offers Section 502 Direct and Guaranteed Rural Housing loans to
homebuyers living in rural areas. Section 502 Direct loans offer reduced
interest rates to lower-income borrowers who qualify, and are approved directly
through local USDA County Agents or through USDA Rural Development state
offices.
A limited amount of funding is available for Section 502 Direct loans, so some
lenders offer “Leveraged Loan” programs. Leveraged loans combine a Section 502
Direct loan that has a low interest rate with a conventional, market-rate loan.
The “blended” interest rate on the resulting loan is lower than the current
market rate as a result of the combination of the rates on the two loans.
State Housing Finance Agency Loans
State Housing Finance Agencies (HFA) provide loans to first-time homebuyers,
usually at below-market interest rates. Program availability and eligibility
requirements generally vary from state to state. You should check with your
state HFA for programs that are currently available.
Adjustable Rate Mortgages (ARMs)
With a fixed-rate mortgage, the interest rate stays the same during the life of
the loan; however, with an ARM, the interest rate changes periodically,
typically in relation to a specific index such as a cost of funds rate or the
Treasury bill rate. Payments may go up or down consequently. Adjustable-rate
mortgages (ARMs) are distinguished by the time frame for adjustment, such as 1
year, or 3, 5, 7, or 10 years. Hybrid ARMs have grown in popularity because they
offer a favorable fixed rate of interest for a time, such as 3, 5, 7, or 10
years, after which the loan becomes a 1-year ARM.
Lenders usually charge lower initial interest rates for ARMs and Hybrid ARMs
than for fixed-rate mortgages. This makes the ARM easier on your wallet at first
than a fixed-rate mortgage for the same amount. Also, you might qualify for a
larger loan because lenders sometimes make this decision on the basis of your
current income and the expected monthly payments for the next year or two.
Moreover, if interest rates remain steady or move lower, your ARM could be less
expensive over a long period of time than a fixed-rate mortgage.
However, you have to weigh the risk that an increase in interest rates would
lead to higher monthly payments in the future. It's a trade-off: you get a lower
rate in exchange for assuming more risk.
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