Loan Programs

There are many loan programs available – too numerous to cover them all so we’ve highlighted the programs most commonly available today. Characteristics of each loan program are unique, so lets breakdown the components so you have a better idea of the similarities and then it’s much easier to see the differences and how to help determine the best loan program for you. This is critical! We see people trying to save hundreds shopping for rate and losing thousands by selecting the wrong product and/or structure of products.

Pretend you are the Lender and you have money to lend… Like a TV, a toaster or a set of tools, money is the Lender’s product. This is the reason we have so many Products. You want to hang a picture… Hammer and nail or screwdriver and screw? Both will work… Is one better?

Think like a Lender! Learn to speak like a Lender.  How long will you give the borrower to pay you back? This is called “TERM”. 30 and 15 year would be the most common but it could be 12 or 40 years. How will you structure the payments?  “AMORTIZATION”. Start with x (amount borrowed) and end at 0 (loan paid off). It’s the mix of principal and interest. You could have a 30/15… 30 Amortization with 15 Term. This is called a “BALLOON”. Your payments were based on a 30 year pay off (amortization)but the term is for 15, so at the end off the term you have a balloon (unpaid balance due in 1 lump sum). “RATE” is simple… it’s the interest rate used to calculate the payment of “PRINCIPAL” and “INTEREST” on most loans. An exception to this would be “INTERST ONLY”. Just like it states… just interest, NO principal. You might see this on a 30 yr fixed (rate & term) loan, 10 years interest only and then the remainder is 20 years amortized (principal and interest). Interest only should not be confused with “NEGATIVE” “NEGATIVE AMORTIZATION” which means the payment on the loan is not sufficient to cover the interest and the deficit will be added to the balance of the loan and may also be called “DEFERED INTEREST”. If you did not specifically ask for this product and completely understand the risk, if you hear these words you may want to run away. Also may be called an equity builder combined with a bi-weekly. A true bi-weekly is OK as long as you don’t have to pay extra for it. (for explanation “BI-WEEKLY”)

Let’s recap… “RATE” is simple… really… mortgages are simple interest. The chart shows the P & I breakdown for the first payment with varied “TERM” & “AMORTIZATION”. The difference is how much and when you pay back the “PRINCIPAL” … this is how the Lender changes the characteristics of particular loan products!

$250,000 Loan Amount
1stPayment Principal Interest Rate Term Amortization
2,651.64 1,699.97 1,041.67 5.000 10 years 10 years
1,976.99 935.32 1,041.67 5.000 15 years 15 years
1,342.05 300.38 1,041.67 5.000 15 years 30 years
1,342.05 300.38 1,041.67 5.000 30 years 30 years
1,041.67 0 1,041.67 5.000 30 years 10/IO 20 years

That is the basis of how all fixed rate loans work. The same mechanics work for and “ARM” (adjustable rate mortgage) except now there is a provision that the ‘RATE” can also change. Let’s break down the ARM.

Again I want you to think like a Lender. Would you lend at the same rate for 30 years as you would for 7 years? Of course not… less risk. So we know that arms include, “TERM”, “AMORTIZATION”, and a breakdown of ‘PRINCIPAL” & “INTEREST” like a fixed. They can “BALLOON”  be “INTEREST ONLY” and also be “NEGATIVE”. The difference is that the rate can change! Sound s Scary… it can be but let’s see how they work. A little more Lender speak. First let’s cover “INDEX”. The index is what the loan is tied to such as “LIBOR” (london inter bank offer rate), “T-BILL” (treasuries), “PRIME” (prime rate), COFI (cost of funds index) and a few others but they are all fairly similar. Next you have a “MARGIN”. Let’s call it profit margin which is not completely correct but it helps us remember. The “INDEX” + “MARGIN” = “INDEXED RATE”. This is how you would track the market interest rate and forsee future adjustments up or down with your rate and payment. Most loans will also have “CAPS”. The caps are expressed as 5-2-5 or 2-2-6, these are the most common.  The first number is the percentage cap the rate can move at the first adjustment. The 1st adjustment could be 1 month or even up to 10 years (rate fixed for the 1st 10 years would be called a 10-1, or fixed 5 years would be a 5-1). The second number is each subsiquent year after the initial adjustment and the last number it the lifetime percentage cap max up or down.

$250,000 Loan Amount, 7-1 ARM, 2.75 Margin, 2-2-6 Cap
84 Payments 12 payments Index Margin 1st Adj Rate Start Rate Term Amortization
1,175.59 1,149.75 .900 2.75 3.650 3.875 30 years 30 years
1,175.59 1,219.35 1.5 2.75 4.250 3.875 30 years 30 years
1,175.59 1,418.85 4 2.75 5.875 3.875 30 years 30 years

As you can see after 84 payments on a 7-1 the rate may go down or up. The 3rd line on the grid shows the cap kicking in, Market rate at 6.750% but the 2% cap limits it to 5.875%

Other factors to consider and program recaps below

  • Where is the market cycle? Real Estate and the Financial markets run in cycles of 7 to 12 years. Lets assume 8% on a fixed rate loan as average. Above average lean more toward ARMs that will have lower rates and can float down avoiding costly multiple refinances.
  • How important is payment certainty? If knowing that your payment will be the same every month is important, consider a fixed-rate mortgage.
  • How important is rapid equity buildup? If rapid equity buildup is a factor, consider a shorter amortization period, such as a 15-year, fixed-rate mortgage or an ARM with lower rates. Lower rates build equity faster!
  • Do you anticipate increasing or stable income?If income growth is anticipated, you could take advantage of a lower start rate on an ARM or a temporary buydown to quilify for the home you need today.
  • Other factors to consider include:
    • ability to qualify at market rates for loan amount selected
    • anticipated term of occupancy
    • possibility of significant rate changes
    • existence of up-front costs
Loan Programs Characteristics
15- and 30-Year Fixed-Rate Mortgages
  • Interest rate does not change.
  • Principal and interest (P & I) does not change.
  • Fixed-rate mortgages fully amortize over a defined period of time and are paid in-full at the end of the loan term.
  • Different loan terms are available (15- and 30-year terms are most popular).
  • The shorter the term, the faster equity is built and the loan is paid off.
  • Pre-payments shorten the term, payment remains fixed.
Fixed-Rate Balloons
  • P & I payment and interest rate do not change.
  • Regular monthly P & I payments are based on 30-year amortization, while the unpaid balance (balloon) is due at the end of a shorter, predetermined term, typically 5, 7 or 10 years.
  • Interest rate is typically less than fixed-rate loans.
  • Most borrowers anticipate refinancing or selling prior to the end of the balloon term.
Fixed-Rate with Temporary Buydown
  • Borrowers or the seller may pay to temporarily “buy down,” or lower, the interest rate.
  • Decreased interest rate reduces the monthly payment.
  • Lower interest rate may help borrowers qualify more easily; qualifying factors may vary.
  • Interest rate/payment is typically reduced for 1, 2 or 3 years
Interest-Only Mortgages
  • There are no reductions to the principal amount.
  • There is no provision for negative amortization.
  • Payments may increase up to an amortized amount, but the loan balance itself does not increase.
  • Generally, interest-only payments are limited to the first 5, 10 or 15 years of the loan.
  • After that, the loan is amortized for the remainder of its term
Adjustable-Rate Mortgages (ARMs)
  • There is potential for the interest rate/ payment to fluctuate.
  • ARMs transfer to borrowers a portion of the risk associated with a changing economy.
  • In exchange for sharing the risk, ARMs offer borrowers initial interest rates that are substantially lower than fixed-rate mortgages.
  • The lower interest rate may help borrowers qualify more easily; qualifying factors may vary.
  • Pre-payments lower the monthly payment, Term remains the same.

Bi-Weekly Mortgages: A true biweekly consists of 26 payments (1/2 normal payment) per year. Two things occur, the first is that the payment must be auto drafted from your account and posted against you principal. Second you end up making 13 payments instead of 12 per year. (pre-paying) This must be setup prior to closing!!! This is a type of mortgage not just a payment option. Most Lenders charge a higher interest rate so they may not be a good value.

Please be careful of people who try to sell you a bi-weekly program after closing. They will charge hundreds of dollars in fees upfront and monthly for drafts. Your payments will be bi-weekly to them but will post monthly with your Lender! You can pre-pay direct with your lender (1 payment /12 and add to monthly) same thing and no added fees.

For further expaination on arms you can download this booklet from the Mortgage Bankers Association “Mort Banker Booklet”

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