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Step 2: Understanding Different Types of Mortgages
(NOTE: These are informal definitions just to convey the meaning.)
What is a Mortgage Loan ?
It may be confusing but a Mortgage Loan is technically not a loan but a document that is filled in to offer security or collateral for a loan. By signing this document you give the lender the right to obtain the Real Estate property if you do not honor your end of the agreement (i.e. payment of mortgage). You are basically pledging your property as a security without giving away the title. This is the Mortgage Loan.
What is a Mortgage ?
Mortgage is what you periodically pay to the lender who is servicing your mortgage loan.
What are the different Types of Mortgage Loans ?
There are different types of mortgage loans which are offered by different lenders as different products. Even if a product seems somewhat similar between mortgage lenders, the fees and mortgage costs associated with it may vary from one lender to another. Some of the most widely known products are described below:
Fixed Rate Mortgage: A fixed rate mortgage is one where the interest rate does not change for the length of the loan. The loan is amortized over the length of the term and the per month mortgage payment is fixed. Note that there may be some variations in the mortgage payment but those may be a consequence of the real estate taxes or other components but not due to the loan itself.
15 year Fixed Rate Mortgage: The term for this fixed rate mortgage loan is 15 years. In other words the mortgage and interest has to be paid back in 15 years. The mortgage payment per month remains same all throughout the life of the loan.
30 year Fixed Rate Mortgage: The term for this fixed rate mortgage loan is 30 years i.e. the mortgage and interest has to be paid back in 30 years. The mortgage payment per month remains same all throughout the life of the loan. The difference between this and the 15 year fixed rate mortgage (in addition to the difference in the number of years) is that the per month mortgage for 30 year fixed is less than the per month mortgage for 15 year fixed for the same mortgage amount. Lenders typically offer the 15 year fixed at a somewhat lower interest rate than the 30 year fixed.
Adjustable-Rate Mortgage: An ARM mortgage, as the name suggests has an adjustable rate against which the mortgage payments are calculated. As a result your mortgage payments may go up or down throughout the life of your loan. The rate against which your mortgage is calculated is based upon a published market index which in many cases is a One-Year treasury bond index or our favorite the Cost Of Funds Index (COFI). The interest rate that applies to you is the sum of such an index and a margin which is generally set during your loan application process. So, for example, if the index is 7.5% and your margin is 2.5% then your rate is 10.0%. This rate is adjusted by your mortgage lender at every pre-determined interval which is known as the Adjustment Interval. So, a One-year ARM is said to have an Adjustment interval of once every year. In addition to such periodic adjustments, it is possible that the very first adjustment may occur earlier or later than all the other adjustments. For instance a one-year ARM mortgage may have the very first initial adjustment after 2 years of your taking out the mortgage loan, followed by an adjustment every once a year. Your initial interest rate is determined at the beginning of your loan process and may be different than the sum of the current index plus margin.
In addition to the Initial Interest Rate, Index, Margin and Adjustment Interval, your mortgage lender may also offer an Interest rate cap and Periodic Interest Rate cap. These upper limit caps protect you against high interest rates for the life of the loan which means that your interest rate would not exceed this cap, even if the sum of margin plus index exceeds these limits.
Convertible to Fixed Rate ARM: This is an optional feature offered by the lender which enables you to convert your ARM to a Fixed rate mortgage loan after some time has elapsed. This option may be useful for those who want to stabilize their mortgage payments to a fixed amount after some time of adjustments. The rules for converting differ between lenders and therefore it is important that you understand these options as offered by your lender.
NOTE: The intent of this list is to informally give a description of some Mortgages. There are many-many other types of mortgages available. Please consult lenders in your area for a detailed description of the Mortgage Loan Products they offer. The products offered by these lenders may be different than those described here.
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