Mortgage Glossary- Part One

The Most Common Mortgage Types and Their Uses

Bankers have come up with a whole smörgåsbord of different mortgages, trying to satisfy all the people all the time. This is a glossary of the more common terms.

When shopping for a mortgage this might help you make sense of all the different options that are available to you.

[Since the onset of the Subprime Mess, you will probably find a lot of the more exotic mortgage types are no longer offered.]

Mortgages Made Simple?

15 vs 30 Year Term Mortgages

Your mortgage term can be just about any length you choose. A 30 year fixed rate mortgage was what used to be - and probably still is for most people - considered a conventional mortgage.

15 and 30 year terms are popular these days, although 10 and 20 years also are available.

The shorter the term, the lower the interest rate. But the main attraction of shorter term mortgages is the money you save.

For example on a $200,000 mortgage with a fixed 4.5% rate, you would pay $1013.38 a month for 30 years and $1529.99 a month for 15 years. Over 30 years you would pay $364,816.80 versus $275,398.20 over 15 years, a savings of $89,418.60 or 24.5% in interest.

If you cut a very conservative quarter of a percent off for reducing the lenders exposure by 15 years, your savings will be nearly 26%.

Use the mortgage calculator to try different scenarios.

Adjustable Rate Mortgages (ARM)

ARM’s are mortgages whose rates adjust according to the terms of the contract you made with the lender.

Usually interest rates are fixed for the first 1, 3, 5, 7 or even 10 years. After that period is up, rates will be allowed to fluctuate within the limits of your contract with the lender.

Terms are usually 15 or 30 years (although you can negotiate just about any duration you want). There can be a balloon payment involved.

Because the lender is not taking as big a risk on losing money if interest rates rise, these loans will have a lower initial rate than a fixed mortgage. The lowest rates will be for 1 year ARM’s and will go up accordingly.

Many people will take out an ARM even in period of low rates, such as now, because they get even lower rates and are able to afford more house. However, the borrower is taking the risk that he can still afford the house after the rates are free to rise.

It used to be common for the mortgage contract to limit fluctuations to 2% a year. However, 5% swings are becoming more the norm. Depending on what happens to interest rates, you might find yourself priced out of your house. (Read Time to Refinance? to learn about how homeowners who are finding themselves forced to sell for just this reason.) Of course, you could try to refinance if rates start to go back up.

The average homeowner owns his or her house for approximately 7 years. If you plan to move before the initial fixed term of the ARM is up, it’s a good choice. If you plan to stay longer than ten years, a fixed rate might be a better option.

Balloon Mortgage

A balloon mortgage is one that is not completely paid off at the end of its term. In other words, it is not fully amortized.

For example, you might obtain a 15 year fixed rate mortgage that allows you to pay less than the normal amortization schedule would call for. At the end of the 15 years, you will still owe a portion of the principal. How much depends on the terms of the contract.

An interest only mortgage is an example of balloon mortgage. In the case of an interest only loan, the balloon will be the full amount you originally borrowed.

This type of mortgage allows borrowers either to afford more house then they otherwise could buy or its reduces their monthly costs, allowing them to spend or invest their savings elsewhere.

The lender does not generally allow interest only payments for the life of the loan. They are usually limited to the first ten years, at which time the entire mortgage balance is amortized over the remaining life of the loan, usually 20 years.

Again, if you are planning to move before the balloon is due and your proceeds from the sale are enough to cover the balloon, this might be a good idea. However, you face the very real possibility of having to come up with cash when you sell to cover the balloon, especially if you have to sell at a time of declining housing prices, which is occurring now (December 2006 throuth April 2008) in at least some parts of the country.

Here are links to the rest of this article:

Mortgage Glossary- Part Two

Mortgage Glossary - Part Three

Mortgage Glossary - Part Four

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