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Fixed Rate Mortgages
The most common type of mortgage program where your monthly payments for interest and principal never change. Property taxes and homeowners insurance may increase, but generally your monthly payments will be very stable.
Fixed-rate mortgages are available for 30 years, 20 years, 15 years and even 10 years. There are also "bi-weekly" mortgages, which shorten the loan by calling for half the monthly payment every two weeks. (Since there are 52 weeks in a year, you make 26 payments, or 13 "months" worth, every year.)
Fixed rate fully amortizing loans have two distinct features. First, the interest rate remains fixed for the life of the loan. Secondly, the payments remain level for the life of the loan and are structured to repay the loan at the end of the loan term. The most common fixed rate loans are 15 year and 30 year mortgages.
During the early amortization period, a large percentage of the monthly payment is used for paying the interest . As the loan is paid down, more of the monthly payment is applied to principal . A typical 30 year fixed rate mortgage takes 22.5 years of level payments to pay half of the original loan amount.
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Adjustable Rate Mortgages (ARM)
These loans generally begin with an interest rate that is 2-3 percent below a comparable fixed rate mortgage, and could allow you to buy a more expensive home.
However, the interest rate changes at specified intervals (for example, every year) depending on changing market conditions; if interest rates go up, your monthly mortgage payment will go up, too. However, if rates go down, your mortgage payment will drop also.
There are also mortgages that combine aspects of fixed and adjustable rate mortgages - starting at a low fixed-rate for seven to ten years, for example, then adjusting to market conditions. Ask your Mortgage Advisor about these and other special kinds of mortgages that fit your specific financial situation
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Standard ARMS and the Differences
A few options are available to fit your individual needs and your risk tolerance with the various market instruments.
ARMs with different indexes are available for both purchases and refinances. Choosing an ARM with an index that reacts quickly lets you take full advantage of falling interest rates. An index that lags behind the market lets you take advantage of lower rates after market rates have started to adjust upward.
The interest rate and monthly payment can change based on adjustments to the index rate.
6-Month Treasury Average ARM
Has a maximum interest rate adjustment of 1% every six months. The Treasury Average index generally reacts more slowly in fluctuating markets so adjustments in the ARM interest rate will lag behind some other market indicators.
12-Month Treasury Average ARM
Has a maximum interest rate adjustment of 2% every 12 months. The treasury Average index generally reacts more slowly in fluctuating markets so adjustments in the ARM interest rate will lag behind some other market indicators.
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Introductory Rate ARM's
Most adjustable rate loans (ARMs) have a low introductory rate or start rate, some times as much as 1.0%. This start rate is usually good from 1 month to as long as 10 years. As a rule the lower the start rate the shorter the time before the loan makes its first adjustment.
Index - The index of an ARM is the financial instrument that the loan is "tied" to, or adjusted to. The most common indices, or, indexes are the 1-Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month Certificate of Deposit (CD) and the 11th District Cost of Funds (COFI). Each of these indices move up or down based on conditions of the financial markets.
Margin - The margin is one of the most important aspects of ARMs because it is added to the index to determine the interest rate that you pay. The margin added to the index is known as the fully indexed rate. As an example if the current index value is 5.50% and your loan has a margin of 2.5%, your fully indexed rate is 8.00%. Margins on loans range from 1.75% to 3.5% depending on the index and the amount financed in relation to the property value.
Interim Caps - All adjustable rate loans carry interim caps. Many ARMs have interest rate caps of six-months or a year. There are loans that have interest rate caps of three years. Interest rate caps are beneficial in rising interest rate markets, but can also keep your interest rate higher than the fully indexed rate if rates are falling rapidly.
Payment Caps - Some loans have payment caps instead of interest rate caps. These loans reduce payment shock in a rising interest rate market, but can also lead to deferred interest or "negative amortization". These loans generally cap your annual payment increases to 7.5% of the previous payment.
Lifetime Caps - Almost all ARMs have a maximum interest rate or lifetime interest rate cap. The lifetime cap varies from company to company and loan to loan. Loans with low lifetime caps usually have higher margins, and the reverse is also true. Those loans that carry low margins often have higher lifetime caps.
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London InterBank Offered Rate (LIBOR)
LIBOR is the rate on dollar-denominated deposits, also know as Eurodollars, traded between banks in London. The index is quoted for one month, three months, six months as well as one-year periods.
LIBOR is the base interest rate paid on deposits between banks in the Eurodollar market. A Eurodollar is a dollar deposited in a bank in a country where the currency is not the dollar. The Eurodollar market has been around for over 40 years and is a major component of the International financial market. London is the center of the Euromarket in terms of volume.
The LIBOR rate quoted in the Wall Street Journal is an average of rate quotes from five major banks. Bank of America, Barclays, Bank of Tokyo, Deutsche Bank and Swiss Bank.
The most common quote for mortgages is the 6-month quote. LIBOR's cost of money is a widely monitored international interest rate indicator. LIBOR is currently being used by both Fannie Mae and Freddie Mac as an index on the loans they purchase.
LIBOR is quoted daily in the Wall Street Journal's Money Rates and compares most closely to the 1-Year Treasury Security index.
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Balloon Mortgages
Balloon loans are short term mortgages that have some features of a fixed rate mortgage. The loans provide a level payment feature during the term of the loan, but as opposed to the 30 year fixed rate mortgage, balloon loans do not fully amortize over the original term. Balloon loans can have many types of maturities, but most balloons that are first mortgages have a term of 5 to 7 years.
At the end of the loan term there is still a remaining principal loan balance and the mortgage company generally requires that the loan be paid in full, which can be accomplished by refinancing. Many companies have other options such as a conversion feature at the end of the term. For example, the loan may convert to a 30 year fixed loan at the thirty year market rate plus 3/8 of a percentage point. Your conversion can be guaranteed based on certain criteria such as having made your last 24 payments on time. The balloon mortgage program with the conversion option is often called a 7/23 Convertible or 5/25 Convertible.
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Cost of Funds Index (COFI)
The 11th District Cost of Funds is more prevalent in the West and the 1-Year Treasury Security is more prevalent in the East. Buyers prefer the slowly moving 11th District Cost of Funds and investors prefer the 1-Year Treasury Security.
The monthly weighted average Eleventh District has been published by the Federal Home Loan Bank of San Francisco since August 1981. Currently more than one half of the savings institutions loans made in California are tied to the 11th District Cost of Funds (COF) index.
The Federal Home Loan Bank's 11th District is comprised of saving institutions in Arizona, California and Nevada.
Few people who use and follow the 11th District Cost of Funds understand exactly how it is calculated, what it represents, how it moves and what factors affect it.
The predecessor to the 11th District Cost of Funds index was the District semiannual weighted average cost of funds published for a six month period ending in June and December. The San Francisco Bank was the first Federal Home Loan Bank to publish a monthly cost of funds index.
The funds used as a basis for the calculation of the 11th District Cost of Funds index are the liabilities at the District savings institutions: money on deposit at the institutions, money borrowed from a Federal Home Loan Bank (known as advances) and all other money borrowed. The interest paid on these types of funds is the cost of these funds.
The ratio of the dollar amount paid in interest during the month to the average dollar amount of the funds for that month constitutes the weighted average cost of funds ratio for that month.
The average cost of funds is said to be weighted because the three kinds of funds and their costs are added together before a ratio is computed rather than calculating averages individually for the three sources and using a simple average of the three ratios. This gives the greatest weight to the interest paid on deposits, and explains the delayed reaction of the index to rising fixed-rate mortgages.
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Choosing A Mortgage Program
There isn't a single or simple answer to this question. The right type of mortgage for you depends on many different factors:
Your current financial picture.
How you expect your finances to change.
How long you intend to keep your house.
How comfortable you are with your mortgage payment changing.
For example, a 15-year fixed-rate mortgage can save you many thousands of dollars in interest payments over the life of the loan, but your monthly payments will be higher. An adjustable rate mortgage may get you started with a lower monthly payment than a fixed-rate mortgage -- but your payments could get higher when the interest rate changes.
The best way to find the "right" answer is to discuss your finances, your plans and financial prospects, and your preferences frankly with a mortgage professional.
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No Doc or Limited Doc Loans
There is one basic mortgage
principle: the more documentation you provide your lender (employment,
income and credit history) the lower your interest rate will
be; however, some borrowers choose not to offer documentation,
and willingly opt for a higher interest rate. Yet, many of these
homebuyers have a healthy income, or savings, and a good credit
history. No Doc (documentation) or Limited Doc loans often attract
homebuyers who are willing to pay a premium for provided less
documentation, or ease. Some buyers don’t care to have their entire life
and financial history presented to the lender. They might be using
an inheritance to secure a loan or have fluctuating income from
owning their own business. Ease is a big factor as well. With
a No Doc loan, the borrower provides their name and social security
number, along with information regarding the property being purchased.
The rest is up to the lender.
Three Types of No Doc & Limited Doc
Loans
No Doc Loans—These require the least documentation
and are for buyers with good credit. The buyer provides
minimal information and the lender does the rest. No Doc
loans are great for people who want maximum privacy.
Stated-Income (Limited Doc) Loans--People who work on a cash
or commission basis - people who don’t draw a regular
salary, typically use a stated income mortgage to purchase
or refinance a home. This borrower will need to disclose earnings,
usually for two years, and might need to show tax returns
and bank statements.
No Ratio Loans--No Ratio loans are for borrowers who do not
wish to disclose their income, therefore there is no debt-to-income
ratio for the lender to consider. The No Ratio borrower
has good credit and abundant assets that make up for the lender
not considering the borrower’s income information.
This loan can offer a quick and easy process to borrowers
for whom gathering documentation could be a logistical
nightmare.
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Interest Only Loans
A mortgage is “interest only” if
the monthly mortgage payment does not include any repayment
of principal for some period. The payment consists of interest
only. During that period, the loan balance remains unchanged.
For example, if a 30-year fixed-rate loan of $100,000 at 8.5%
is interest only, the payment is $708.34. Otherwise, the
payment would be $768.92. This is the “fully amortizing payment” – the
payment that, if maintained over the term of the loan, will
pay it off completely. The interest only loan thus reduces the
monthly payment by 7.9%.
A loan that is interest-only for the full term would not
amortize. The loan balance would be the same at term as
it was at the outset. Hence, the interest only loans of
today are interest only for a specified period, such as
5, 10 or 15 years. At the end of that period, the payment
is raised to the fully amortizing level. In such case, the
new payment will be larger than it would have been if it
had been fully amortizing at the outset.
Interest only mortgages are for borrowers who want a lower
initial payment, and have some confidence that they will
be able to deal with a payment increase in the future.
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Option ARM
An issue for many homeowners is managing
monthly income and expenses, or "cash flow". Income
varies for many reasons and unplanned expenses come up when
least expected. For many, your mortgage payment is the largest
monthly expense, and also the least flexible. The Option ARM
was designed to give you control over your mortgage payment.
You can choose one of four payment options monthly based on
your specific cash flow needs and The Option ARM allows you
to choose your index from the 1 month LIBOR or the MTA.
Option One: Minimum Payment--A payment is set for 12 months
at a reduced rate. The minimum payment rate for the 12 month
option is 1.00%. This maximizes cash flow but may also defer
payment of interest on your mortgage allowing flexibility
in managing your tax deductions. This minimum payment can
not increase by more than 7.5% each year.
Option Two: Interest Only Payment--Defer paying principal
on your loan and improve your monthly cash flow.
Option Three: Fully Amortizing Payment Options--You have
the ability to make a full payment based on either a 30
year or 15 year payment schedule.
To illustrate how these payments may differ, let's assume
you've taken out a $150,000 mortgage with an interest rate
of six percent, and your lender offers an initial rate
of three percent for the minimum payment. Your options
would look like this:
Minimum payment $632.41
Interest only $750.00
30-year amortized $899.33
15-year amortized $1,265.79
What's more, if you defer too much interest, you can reach
what's called negative amortization. If you are paying
less than the interest only payment, your principal balance
will increase and if your balance rises 10 percent above
the original principal, your loan is automatically recast
and you have to start paying the fully amortized rate.
Another potential downside of option ARMs is that they're more
complicated than most other mortgages. Home buyers may be seduced
without fully understanding how much the minimum payments will
increase over the long-term. When the monthly amounts go up, these
people can experience payment shock.
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Home Equity Loans and Home
Equity Lines of Credit
Second mortgages or equity loans can serve several purposes.
You can renovate your house, pay off debt, or even refinance
to take out an education loan.
A home equity loan is a lump-sum loan and is generally amortized
like most first mortgage loans. The difference is that the
home equity loan is a second loan against your home behind
the first mortgage that you already have. The closing costs
for a second mortgage are lower than closing costs on a
first mortgage loan. The rates on home equity loans are fixed
rates that are slightly higher than fixed rates on first mortgages.
A Home Equity Line of Credit is similar to a home equity
loan. There are some differences that make a difference:
• Variable rate On a home equity line of credit the interest
rate is can fluctuate from month to month. This makes
the home equity line of credit appealing when interest rates
are low, but risky when interest rates increase.
• Continual use You can use the account as long as there funds.
This kind of home equity line of credit is similar to
a credit card, where you have a balance and available credit line.
• Future amortization At some predetermined period (5, 10,
or sometimes 20 years) you will no longer be able to
draw against the account. At this point you will be required to pay off the loan,
making monthly payments on the principal and the interest.
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