Loan Programs

Let’s look at the basic loan types. Then we will go into detail.

Basic Loan Types

Fixed Rates – Fixed rate mortgages have level, constant payments of principal and interest because the interest cannot change. It is fixed. The most common terms for fixed rate loans are 15 and 30 years, but loans can be amortized over 10, 20, or 25 years. These are the safest, most secure loan programs. The level monthly payment loans make fixed rate loans attractive to those staying in properties over 8 – 10 years.

Adjustable Rate Mortgages (ARM’s) – These loans have a fixed period during which time the payments are fixed and level. For example, a 3/1 ARM is fixed for the first three years, then becomes a 1 Yr. adjustable rate fro years 4 – 30, adjusting every year to a new rate, subject to annual and lifetime caps on increases and decreases. The adjustment each year after the initial fixed rate period is determined by this formula; Rate = Index plus Margin. The most common index is the US 1 Year Treasury Constant Maturity. The margin is determined by the lender, usually between 2.75% and 3.00%. Rate adjustment caps generally apply to limit increases in rate per adjustment and over the life of the loan. ARM’s are for the more sophisticated borrower who knows the length of time in the property is limited or knows that a refinance opportunity will occur during the initial fixed rate period of the ARM.

Balloon or Two-Step Mortgages – These are fixed rate loans that generally have a 5 year or 7 year fixed rate period. At the end of the fixed rate period, These loans will have a balloon, or final payment provision, or have a lender-opted conversion to a new fixed rate for the remaining 25 or23 year term.

Certain criteria must be met on a two-step loan for the lender to grant a new term at a new interest rate. It is likely that the conversion feature on the two-step loan is not valuable to borrowers since the conversion rate is slightly higher than what they could refinance their loan for on the open market.

Piggyback 1^st’s and 2^nd’s – A combination loan of a 75% or 80% 1^st mortgage and a 15% or 10% 2^nd mortgage can help savvy borrowers escape paying Private Mortgage Insurance (PMI) with as little as 5% or 10% down. Normally, a down payment of at least 20% is required to avoid paying PMI. These loans are typically known as 80/10/10’s or 75/15/5’s. These combination loans can be done on fixed rates and most adjustable rate programs. In some cases, an 80/15/5 can be done allowing the qualified borrower to put down only 5%, while still avoiding PMI.

Now, we can take a closer look at the pluses and minuses of specific loan programs.

30 Year Conventional Fixed Rate

Loan amounts from $80,000 to $300.700. Up to 97% LTV Purchase, 90% LTV rate-and-term refinance, 80% LTV cash-out refinance.

Strength: The strength of this loan program is that it offers long term rate security . Payments are fixed for thirty years. Combination 1^st’s and 2^nd’s available to avoid PMI.

Weakness: Compared to ARM’s, it is often the program with the highest rate.

Advice: Recommended to those who do not plan to move or refinance within 8 – 10 years. Paying points to lower the rate is a viable option if the loan is to last more than 4 – 5 years. When rates are historically low, this loan program is a very good choice.

30 Year Jumbo Fixed Rate

Loan amounts from $300,701- $650,000--Up to 95% purchase, 90% refinance, 75% cash-out

Strength: Like it’s conventional counterpart, long-term rate stability is this program’s advantage. Good for those staying in the property for 8 – 10 years. Paying points is a good buy if staying with loan for 4 – 5 years. Combination 1^st’s and 2^nd’s available to avoid PMI.

Weakness: Priced higher in rate than the 30 Yr. Conventional fixed rate.

Advice: If you are one that needs rate security for a long period of time, this program is ideal. However, if you move or refinance, more money could have been saved by taking an adjustable rate program.

15 Year Conventional Fixed Rate

Loan amounts from $80,000 - $300,700--Up to 97% purchase, 90% refinance, 80% cash-out

Strengths: Rate is secure for fifteen years. You will build equity twice as fast because more of your payment goes to principal than on a 30 year amortization. Rates are between .375% to .50% lower than the 30 year fixed rate. Combination 1^st’s and 2^nd’s available to avoid PMI.

Weakness: Payment is generally 1/3 higher than a 30 year meaning that you may not qualify for as much of a loan amount as on a 30 Yr. loan.

Advice: You can save an enormous amount of money in interest over a 30 year loan, and build equity in your property much faster.

15 Year Jumbo Fixed Rate

Loan amounts from $300,701 - $650,000. Up to 95% Purchase, 90% rate-term refinance, and 75% cash-out

Strength: Like it’s conventional counterpart, rate security is a key feature. Faster equity build-up results from amortizing over 15 years instead of 30 years. Combination 1^st’s & 2^nd’s available to avoid PMI.

Weakness: You will not qualify for as much as on a 30 Yr. loan because the payment is generally 1/3 higher than that on a 30 Yr. loan.

Advice: To build equity faster and have rate security for a stay in the property from 9 – 15 years, this is a great program. The savings on a 15 Year loan over a 30 Yr. loan are very great. In fact they are staggering.

3 Year Adjustable Rate Mortgage (3/1 ARM)

30 Year amortization, Rate is fixed 3 years, then adjusts yearly, Loan amounts from $80,000 - $650,000--Up to 90%- 95% purchases, 90% refinances. Cash-out LTV’s vary

Strength: You can qualify for a loan amount at the initial rate, giving you the ability to qualify for the highest loan amount. With a three-year fixed period, there is some rate security combined with a low starting and qualifying rate.

Weakness: With only three years of fixed rate security, is that fixed rate security long enough for the period of time you plan to stay in the property?

Advice: If length of stay in the property is 3 to 5 years and you need a lower qualifying rate to get the loan amount you need, the 3/1 ARM offers a great value. Timing of interest rate cycles may offer a refinance opportunity.

5 Year Adjustable Rate Mortgage(5/1 ARM)

30 year amortization, Rate is fixed 5 years, then adjusts yearly. Loan amounts from $80,000 - $650,000--Up to 90% - 95% purchases, 90% refinances. Cash-outs LTV’s vary.

Strength: Since the average life of a mortgage loan is between 5 and 7 years, the rate security offered by the 5/1 ARM is adequate for many borrowers. The rate differential between the 30 Yr. fixed rate and the 5/1 ARM is generally great enough to yield real monetary savings for borrowers. Qualification is at the fixed starting rate, allowing for qualification for greater loan amounts.

Weakness: Does five years fixed give you enough rate security?

Advice: The 5/1 ARM may be the most versatile qualifying and rate secure program offering you enough time and power to meet your needs.

7 Year Adjustable Rate Mortgage(7/1 ARM)

30 Year amortization, Rate is fixed 7 years, then adjusts yearly. Loan amounts from $80,000 to $650,000--Up to 90% to 95% purchases, 90% refinances. Cash-outs LTV’s vary.

Strength: Lengthy fixed rate period (perhaps more than you will need).

Weakness: Rate differential between 7/1 ARM and 30 Yr. fixed is not as great, bringing into question whether the risk of being there past the fixed rate period is worth the slight rate savings.

Advice: If your length of stay in the property will be 7 – 8 years and you desire a slightly lower rate, this may be an adequate choice.

Take time to consider which of these programs best suits your needs. Consider the expected length of time you in the property, along with the amortization period desired to narrow down your choices. Once you've selected your program, your comparison of closing costs can begin in earnest. Compare not only the rate a lender offers, but also their total costs to you. Remember, it's your money.

Alex S. Watkins - Mortgage Master