Types Of Mortgage Loans and Home Loans Explained 2018


Conforming and Noncomforming Loans

There is many types of mortgage loans. Conventional loans are loans made by private parties and nongovernment lending institutions without any government insurance or government guarantee against loss for the lender. Mortgage loans that are not FHA, VA or USDA (or Rural Housing Service) loans are conventional loans. They may be conforming or nonconforming.

Conventional loans that conform to the eligibility guidelines for purchase by Fannie Mae or Freddie Mac are considered conforming loans. Fannie Mae and Freddie Mac have a maximum loan limit for loans they will purchase, which is adjusted annually.

Loans to persons with satisfactory credit but that exceed this loan limit are called jumbo loans or nonconforming loans. Because these loans cannot be sold to Fannie Mae or Freddie Mac, they often have a higher interest rate than conforming loans.

Insured Loans

Conventional loans can be insured or uninsured. Generally, a conventional loan of up to 80 percent of the property’s value will be made without private mortgage insurance. Some lenders will charge higher interest rates to compensate for the increased risk inherent in making a loan that is more than 80 percent of the value; however, most require that the loan be insured by a private mortgage insurance company.

Private mortgage insurance (PMI) is an insurance policy issued to provide protection to the mortgage lender in the event of financial loss due to a borrower’s default that results in foreclosure. In the event of a foreclosure, the insurance company will either purchase the loan or let the lender foreclose and pay the lender for losses up to the face amount of the policy.

So that he may get a loan with a small down payment, the borrower pays a mortgage insurance premium either as a lump sum at closing covering the life of the loan, or by paying the first year’s premium at closing and then paying annual premiums as part of his mortgage payment. The amount of the premium is a percentage of the loan amount based on the borrower’s down payment. The annual premiums and the insurance stop automatically once the loan is paid down to 78 percent; or may be canceled at the borrower’s request once the loan balance reaches 80 percent of the value of the property at the time the loan was made.

Subprime Loans – one of Types Of Mortgage Loans

Until 2008, credit-impaired borrowers and other borrowers unable to obtain credit in the prime market were able to easily obtain financing from lenders specializing in subprime loans. Loans made to borrowers meeting Fannie Mae and Freddie Mac credit requirements are called A-paper loans. A-paper loans are conforming loans. Loans not meeting these requirements were called “Alt-A,” “B,” “C” and “D” paper loans, or subprime loans. Alt-A loans were treated as “A-” (A-minus) loans, in some cases because of less-than-prime credit, in other cases because of a lack of supporting documentation.

Factors causing a borrower to seek a loan from a subprime lender include:

  • a weak past credit performance.
  • a high monthly debt payment relative to income.
  • a lack of assets other than current income to support loan payments.
  • self-employment, variable income, or a desire to limit disclosure of his financial situation.

Under the risk-based pricing model used for subprime loans, up-front fees and interest rates were based on the degree of risk posed by the subprime borrower: the higher the risk, the higher a borrower’s rate and costs.

However, due to laxity and abuses in the origination and securitization of subprime loans, the actual loss far exceeded the estimated risk, resulting in bankruptcy and foreclosure for many borrowers and upheaval in primary and secondary markets, as well as real estate markets across the country.

 

Government-Related Loans

Many real estate mortgage loans are insured or guaranteed by the federal government through such programs as:

  • FHA-insured loans.
  • VA-guaranteed loans.
  • USDA-guaranteed loans.

These programs are one of the types of mortgage loans which have more liberal qualification criteria in terms of qualifying ratios and credit standards and higher loan-to-value ratios (LTVs). They also have requirements for some loan terms, including a limit of 4 percent as a late charge on a payment 15 days late and loan assumability.

Federal Housing Administration (FHA) Loans

Definition

The FHA is a division of HUD. FHA loans are loans that meet FHA program criteria and are made by approved lenders. For these loans, the FHA insures the issuing lender against loss in the event of default. Under the FHA program the lender can charge whatever points and interest a borrower is willing to pay, as the cost of the loan is negotiable. The advantage to the borrower is that the lender will make the loan with a very high LTV because it is insured.

However, FHA loan limits restrict the size of mortgages that can be insured by the Federal Housing Administration. The floor for a low-cost area is 65 percent of the national conforming loan limit. This is currently $417,000 for a one-unit property. For areas that have been designated high-cost areas, the ceiling loan limit is 150 percent of $417,000, as prescribed by the National Housing Act and the Economic Stimulus Act of 2008. The following table itemizes the floor/ceiling limits through December 31, 2016. (Single Family Housing Policy Handbook 4000.1)

Property Size

LowCost Area Floor

HighCost Area Ceiling

One Unit

$271,050

$625,500

Two Units

$347,000

$800,775

Three Units

$419,425

$967,950

Four Units

$521,250

$1,202,925

The states and territories of Alaska, Guam, Hawaii and the U.S. Virgin Islands are special exception areas allowing loan limits to be adjusted up to 150 percent of the national ceiling.

Federal Housing Administration (FHA) Loans

Insurance

The FHA funds the insurance from a mortgage insurance premium (MIP) charged to the borrower. Most FHA mortgages require payment of an up-front mortgage insurance premium (UFMIP). The UFMIP is nonrefundable (except to the extent that a portion may be applied to the UFMIP of another FHA-insured mortgage within three years).

In addition, most FHA loans require payment of an annual mortgage insurance premium, payable monthly as part of the mortgage payment. This premium is based on the loan program, the loan term and the LTV.

For loans with FHA case numbers assigned on or after June 3, 2013, the FHA collects the annual MIP for the maximum duration permitted under statute.

  • For all mortgages, regardless of their amortization terms, involving an original principal obligation (excluding financed UFMIP) less than or equal to 90 percent LTV, the annual MIP will be assessed until the end of the mortgage term or for the first 11 years of the mortgage term, whichever occurs first.
  • For any mortgage involving an original principal obligation (excluding financed UFMIP) with an LTV greater than 90 percent, the FHA will assess the annual MIP until the end of the mortgage term or for the first 30 years of the term, whichever occurs first. (12 USC §1709(c)(2)(B), Single Family Housing Policy Handbook 4000.1)
Note
The FHA calculates LTV as a percentage by dividing the loan amount (prior to the financing of any UFMIP) by the lesser of the purchase price (if applicable) or the appraised value of the home. For streamline refinances without appraisals, the FHA uses the original appraised value of the property to calculate the LTV.

Federal Housing Administration (FHA) Loans

The table below shows the previous and the new duration of annual MIP by amortization term and LTV ratio at origination. (Single Family Housing Policy Handbook 4000.1)

 

Term

LTV

Previous

New

≤ 15 yrs ≤ 78% No annual MIP

11 years

≤ 15 yrs 78.01% – 90% Canceled at 78% LTV

11 years

≤ 15 yrs > 90% Canceled at 78% LTV

Loan term

> 15 yrs ≤ 78% 5 years

11 years

> 15 yrs 78.01% – 90% Canceled at 78% LTV & 5 yrs

11 years

> 15 yrs > 90% Canceled at 78% LTV & 5 yrs

Loan term

Under Public Law 111-229(1)(b), the FHA may adjust its mortgage insurance premium rates, as measured in basis points (bps).

This first table shows the previous and the new annual MIP rates by amortization term, base loan amount and LTV ratio. All MIPs in this table are effective for case numbers assigned on or after January 26, 2015.

 

Term > 15 Years

Base Loan Amt.

LTV

Previous MIP

New MIP

≤ $625,500

≤ 95%

130 bps

80 bps

≤ $625,500

> 95%

135 bps

85 bps

> $625,500

≤ 95%

150 bps

100 bps

> $625,500

> 95%

155 bps

105 bps

This second table shows the effective annual MIP rates for loans with terms of up to 15 years. The new annual MIP for these loans is effective for case numbers assigned on or after January 26, 2015.

 

Term ≤ 15 Years

Base Loan Amt.

LTV

Previous MIP

New MIP

≤ $625,500

≤ 90%

45 bps

45 bps

≤ $625,500

> 90%

70 bps

70 bps

> $625,500

≤ 78%

45 bps

45 bps

> $625,500

78.01 – 90%

70 bps

70 bps

> $625,500

> 90%

95 bps

95 bps

The increases in the annual MIP specified in the Single Family Housing Policy Handbook 4000.1 apply to all mortgages insured under the FHA’s single-family mortgage insurance programs except:

  • streamline refinance transactions of existing FHA loans that were endorsed on or before May 31, 2009.
  • Section 247 (Hawaiian Homelands).

 

203(b) Program

The most popular of the FHA loan programs is the 203(b) program. This program helps finance the purchase of a one- to four-unit family home that the borrower intends to occupy as his residence (i.e., move in within 60 days after closing and stay in the property for 12 months), using a 15- or 30-year loan and a cash investment of as little as 3.5 percent of the lesser of the property value or the purchase price. An applicant with a credit score of at least 580 can qualify for the 3.5 percent rate. One with a score of 500-579 can qualify with a cash investment of 10 percent. One with a score below 500 is not eligible for the loan.

Some or all of the cash investment can come from a gift from:

  • an immediate relative.
  • a labor union or employer.
  • a government agency or public entity.
  • a nonprofit charitable organization.

The gift donor, and the source of the gift donor’s funds, may not be a person or entity with an interest in the sale of the property (e.g., the seller, the real estate agent or broker, the builder, or an associated entity). A gift from any of these sources would be considered an inducement to purchase and would have to be deducted from the sales price. Therefore, a seller could not give the buyer a gift directly or channel funds through a nonprofit charitable organization to assist the buyer in acquiring the funds for his down payment.
The FHA allows the seller to contribute up to 6 percent of the purchase price toward the buyer’s actual closing costs, prepaid taxes and insurance, discount points, buydown fees, mortgage insurance premiums, and other financing concessions, but nothing toward the down payment.

Home Equity Conversion Mortgages (HECMs) The FHA’s Home Equity Conversion Mortgage (HECM) is a loan that enables an individual age 62 or older to:

  1. convert some of the equity in his primary residence to cash to pay living expenses; or
  2. purchase a primary residence, if he has the cash to pay the down payment and closing costs.

The borrower may take the loan funds in monthly advances for a fixed period or until he no longer qualifies and/or through a line of credit. Each month’s interest is added to the principal loan balance, causing the interest to be compounded.

The key points regarding HECM loans include the following:

  • The borrower must be 62 years of age or older, have significant equity in the property, occupy the property as his principal residence, and participate in a consumer information session given by an approved HECM counselor.
  • The loan amount is based on the age of the youngest borrower, the current interest rate, and the lesser of appraised value or the HECM FHA mortgage limit. The loan amount may include closing costs.
  • The borrower can select a fixed interest rate or an adjustable rate and choose whether the rate will adjust monthly or annually.
  • The loan has no specified term, prepayment penalties, or credit or income qualifications, as it requires no repayment until either the property is sold or the owner:
    • dies;
    • permanently moves;
    • fails to live in the house for 12 consecutive months; or
    • fails to pay property taxes, maintain hazard and/or flood insurance coverage, or maintain the property (i.e., perform necessary repairs).

Unlike other FHA mortgage programs, the HECM has:

  • a UFMIP of 0.5 percent or 2.5 percent, depending on the disbursements;
  • an annual MIP of 1.25 percent; and
  • a loan origination fee limit of:
    • the greater of $2,500 or 2 percent of the first $200,000; and
    • 1 percent of the amount over $200,000 of value.

    HECM origination fees are capped at $6,000.

    The FHA used to provide a second option, known as the HECM Saver, but the two programs were consolidated in 2013.

HECM Counseling (HUD Mortgagee Letter 2010-37; 2011-26; 2011-31)
All owners shown on the property deed (or legal representative in cases involving documented lack of competency) and a nonborrowing spouse must personally receive HECM counseling prior to entering an HECM contract. The counseling certificate must be signed and dated by:

  • the counselor;
  • all owners shown on the property deed (or legal representative in cases involving documented lack of competency); and
  • the nonborrowing spouse.

Lenders are required to provide each client with a list of HECM counseling agencies that includes no fewer than nine HUD-approved counseling agencies, including:

  • five agencies within the local area and/or state of the prospective borrower;
  • one agency within reasonable driving distance for the purpose of face-to-face counseling; and
  • national intermediaries awarded HECM counseling grant funds by HUD.

Fees and Loan Limits

The FHA allows most loan and closing fees, including discount points and yield spread premiums. However, it does prohibit the borrower from being charged a tax service fee, and it limits:

  • the loan origination fee on its HECM and Section 203(k) rehabilitation loans.
  • appraisal and credit report charges to their actual cost.
  • other closing costs to what would be customary and reasonable.

The maximum insurable mortgage amount is the lesser of:

  • a statutory loan limit for the area (based on housing costs), typically a county or metropolitan statistical area (MSA); or
  • the applicable LTV limit.

Neither limit includes the UFMIP, even if it is added to the base loan amount.

Income and Credit Qualifications

FHA loans are not restricted to first-time homebuyers or those with low or moderate income. Anyone who can meet the FHA’s liberal underwriting criteria can obtain such a loan. The borrower’s income and employment must be verified, and his credit history will be analyzed (e.g., a court-ordered judgment must be paid off or be in the process of being paid off under an agreement with the creditor for regular and timely payments). The FHA also accepts nontraditional mortgage credit reports on borrowers lacking the types of trade references that normally appear on traditional credit reports, provided the information is verified and documented. These may be a substitute or a supplement to a traditional credit report. Such reports include credit references relating to rental housing payments, utility payments and other bill payments (e.g., insurance, child care, phone, auto leases, etc.)

A borrower can qualify for an FHA loan with monthly payments for principal, interest, and property taxes and insurance (PITI) of up to 31 percent of his gross monthly income; and total monthly debt of up to 43 percent of his gross monthly income. In addition, sources of regular income not subject to federal taxes (e.g., certain types of disability and public assistance payments, Social Security income, and military allowances) and child support income can be grossed up by 25 percent in calculating the borrower’s income for qualifying purposes. This means the amount of continuing tax savings attributable to that source may be added to the borrower’s gross income. When a borrower does not have to file a federal income tax return, the tax rate used is 25 percent. On the other hand, the FHA requires that gross rental income be reduced by either 25 percent or a percentage developed by HUD’s jurisdictional Homeownership Center (HOC) for vacancies and maintenance.

Property

Before agreeing to insure a loan, the FHA can require repairs necessary to preserve the continued marketability of the subject property and protect the health and safety of the occupants. If the home requires flood insurance and is not located in an area where the National Flood Insurance Program is in force, it is not eligible for FHA financing.

The FHA requires that a “For Your Protection: Get a Home Inspection” notice be given to a prospective homebuyer at first contact (whether for prequalification, preapproval or initial application), but never later than at the time of the initial application. The notice informs the buyer of the importance of a home inspection prior to purchasing a home. It also makes clear that:

  1. the FHA does not insure the condition of the property.
  2. the appraisal is intended only to assist the lender.

The FHA also requires the use of an amendatory clause in most transactions. This provides that the buyer is not obligated to conclude the transaction and is entitled to a full refund of his earnest money deposit if the property is appraised at less than the purchase price.

Resale

Most FHA loans are assumable, subject to the person assuming the loan qualifying. However, a loan insured after 1989 can only be assumed by an owner-occupant. A lender cannot approve the sale or other transfer of a property to a person (e.g., an investor) who will not be using the property as a primary residence or a secondary residence.

VA loans are made by approved lenders and guaranteed by the U.S. Department of Veterans Affairs. The guarantee is similar to mortgage insurance in that it limits the lender’s exposure to loss in the event of a borrower’s default that results in foreclosure. However, the veteran borrower is charged a nonrefundable up-front funding fee that can be financed, instead of a mortgage insurance premium for the guarantee. A veteran receiving VA compensation for a service-connected disability is exempt from the fee requirement.

The fee varies based on whether the borrower:

is a first-time VA borrower or a repeat borrower;
is eligible because of service in the regular military, or because of service in the Reserves or National Guard; and
puts nothing down, or puts at least 5 percent down.
The fee for a first-time VA borrower who is a veteran of the regular military is 2.15 percent of the loan amount. It is higher if he qualifies as a Reservist or has obtained a VA loan previously. It is lower if he makes a down payment of at least 5 percent. As with the FHA premium, this fee can be financed in the loan.

Advantages of VA Loans

VA loans  are types of mortgage loans that primary advantage of a VA loan is that there is no down payment required on a loan of up to Freddie Mac’s conforming loan limit. In addition, the seller can pay:

  • all of the borrower’s nonrecurring closing costs and discount points, with no limit.
  • up to 4 percent of the sales price in seller concessions (i.e., anything of value added to the transaction for which the borrower pays no additional amount and that the seller is not customarily expected to pay). Concessions include prepaid taxes and insurance, the VA funding fee, payoff of the borrower’s existing debts, temporary buydown fees, and gifts.
    Additionally, it is easier to qualify for a VA loan than for a conventional loan. The VA uses two methods for qualifying its borrowers:

 

  • A 41 percent debt-to-income ratio (including housing and fixed debt)
  • The residual income method, which determines whether the veteran has enough income after paying his fixed debts to cover his daily living expenses and which can qualify a borrower whose ratio might exceed the 41 percent limit
    However, the interest rate is not lower than that for other loans, the seller is generally not required to make repairs, and finance charges are not significantly lower.

 

Eligibility

A VA loan is available only to veterans of the armed services, certain active and discharged military personnel, and their spouses; however, the loan is assumable by nonveterans. In order to obtain the loan, the applicant must obtain a Certificate of Eligibility from the VA (directly online, through the lender online, or by mail). This will determine whether he is eligible for a VA loan and whether he is eligible for a loan with the full guarantee.

The maximum loan guarantee varies depending on the location of the property. While the VA does not have a maximum loan amount, it will guarantee to the lender the lesser of 25 percent of the loan balance or 25 percent of the Freddie Mac limit. For high-cost counties, the guarantee is the lesser of 25 percent of the loan balance or 25 percent of the VA county loan limit, which takes into consideration the county’s median home price and the Freddie Mac conforming loan limit. The guarantee enables the lender to avoid losing money if he can recoup 75 percent of the loan balance from a sale of the borrower’s property at or after foreclosure.

For Example
If the Freddie Mac limit is $417,000, a veteran with full eligibility can get a loan of up to $417,000 without a down payment. The VA will guarantee the lender $104,250 (25 percent) against his loss in the event of default. If the borrower wanted to buy a home for $450,000, the VA would still only guarantee up to $104,250 of the loan. The borrower would need a 25 percent down payment on the balance of the price above $417,000.

If the borrower wanted to buy a $200,000 home, the lender would be guaranteed $50,000 against loss by the VA.

U.S. Department of Veterans Affairs (VA) Loans

An applicant who has used all or part of his entitlement for a VA loan can get it back to purchase another home if any of the following applies:

  1. The prior property has been sold and the VA loan has been paid in full.
  2. A qualified veteran buyer has agreed to assume the outstanding balance on the VA loan and substitute his entitlement for the same amount of entitlement the applicant originally used to get the loan.
  3. One time only, the applicant has repaid the prior VA loan in full without disposing of the property securing that loan.
  4. Even if an existing VA loan has not been paid off, the applicant has “remaining entitlement” due to an increase in the maximum entitlement amount since he obtained that loan.
  5. The borrower must also sign a Certificate of Occupancy, certifying that he will use the property as his primary residence. As with an FHA loan, for a VA loan, the applicant must intend to move in within 60 days after closing and stay in the property for 12 months.

A veteran cannot borrow more than the value shown on the VA appraisal, called a Certificate of Reasonable Value (CRV). He can, however, buy the property for a higher purchase price if he pays the difference in cash. If he does not wish to do so, he can terminate the transaction and receive a refund of his earnest money, utilizing an escape clause required in the VA sales agreement.
The VA does not warrant the condition of the property and is not concerned with cosmetic items, such as chipped paint. However, if the property was constructed before 1978, any area with chipping or peeling paint must be stabilized (i.e., scraped and painted to remove the lead-based paint hazard) and a lead paint notification and disclosure must be provided to the buyer.

The Rural Housing Service (RHS), within the USDA, makes financing available in rural areas through its Section 502 guaranteed loan program.

The loan funds can be used to build, repair, rehabilitate, renovate or relocate a primary residence or to purchase and prepare a site for one, including providing water and sewage facilities. The housing must be modest in size, design and cost and also meet the voluntary national model building code adopted by the state and the Housing and Community Facilities Program’s (HCFP) thermal and site standards.

This program is similar to that offered by the federal VA in that both involve loans with a 30-year term, a fixed interest rate set by the lender, no required down payment and an up-front 2 percent guarantee fee (which may be financed). However, the USDA guarantee applies to 90 percent of the loan. Lenders for this program include state housing agencies and lenders approved for participation in FHA, VA, Fannie Mae or Freddie Mac loan programs.

Loan applicants must:

  • be without adequate housing.
  • have less than 20 percent liquid assets (not including retirement accounts).
  • have a steady income of up to 115 percent of the median income for the area;
  • have a reasonable credit history; and
  • be able to afford the mortgage payments, including taxes and insurance.

The lender must determine repayment feasibility, using 29 percent housing-to-income and 41 percent debt-to-income ratios.
For low-income creditworthy households unable to obtain credit elsewhere, the USDA is authorized to make loans through Section 502.

Fixed-Rate Mortgage (FRM)

Names (or terms) are often applied to mortgages and trust deeds to describe a certain feature of the loan, such as its purpose, the type of interest charged, the security used for the loan, etc. The mortgage or trust deed itself would not show the term, but a feature of that document would cause people to use the term to describe it. In most instances, in fact, one document could be described using any number of terms.

With a level-payment fixed-rate mortgage (FRM), both the interest rate and the monthly principal and interest payments stay the same for the entire loan term. The fixed interest rate will not change, regardless of future changes in the money supply, rate of inflation or anything else. The only possible change in monthly payments on the loan will result from changes in the cost of property taxes and insurance, if those are included in the monthly payment. The lender will change the payment amount after performing its annual escrow analysis.

In the case of a balloon/reset loan (or two-step loan), the interest rate and payments remain fixed for a specified term. At the end of that term, the borrower has the choice of repaying the loan or resetting the interest rate to the current interest rate and having a new fixed rate and payment amount for the remainder of the loan term.

For Example
For a 7/23 loan, the borrower’s payments are based on a 30-year term, but he has to pay off the loan in seven years or have the rate reset to a new fixed rate, which will require a new payment amount for the remaining 23 years. Even though this type of loan has two rates, it is considered a fixed-rate loan.

Fixed-Rate Mortgage (FRM)

Particularly during periods when the interest rates are relatively low, borrowers will select the fixed-rate loan over a variable-rate loan. Those last one are more popular types of mortgage loans. The drawbacks of this type of loan, however, are that:

  • the rate is usually higher than the initial variable rate being offered at the same time.
  • if interest rates were to decrease during the term of the loan, the borrower would have to refinance the loan (i.e., obtain a new loan to pay off all or part of the existing loan) and incur new loan costs in order to take advantage of the lower rates. As a result, during periods of high interest rates more borrowers will lean toward adjustable-rate mortgages (ARMs).
    A fixed-rate loan has no index rate or adjustment period; those are features of an ARM.

 

Adjustable-Rate Mortgage (ARM)

The initial (start) interest rate for an ARM is lower than that for fixed-rate mortgages for those  types of mortgage loans. The initial rate and payment amount will remain in effect for a limited time. After the initial period, the ARM interest rate will be based on an index rate, which increases or decreases periodically during the term of the loan according to an index specified in the loan agreement, plus a fixed margin amount. An ARM is subject to any limits, or caps, on changes in the rate or payment amount.

Amortized Loans

Amortization is the process of paying off a loan by gradually reducing the balance through a series of installment payments.

Fully Amortizing Loan

A fully amortizing (or self-liquidating) mortgage provides for periodic payments that repay the loan in its entirety by the end of the mortgage term. The most common methods of payment used for these loans are:

  • the level payment mortgage, which provides for equal payments of principal and interest throughout the loan period. As the principal balance is paid down, the portion of each payment that applies to the principal increases while the portion applying to interest goes down. However, the total monthly payment remains the same.
  • the budget mortgage, which provides for monthly mortgage payments to include an amount equal to 1/12 of the estimated annual property taxes and property insurance premiums, homeowners’ association dues and/or special assessments.

Partially Amortizing Loan

A partially amortized (balloon) mortgage provides for some, but not total, amortization during the mortgage term. It has payments that are equal and regular in nature. However, the loan term is shorter than the time needed to repay the full loan balance by making those payments. Therefore, at the end of the loan term, a large balloon payment is needed to pay off the remaining balance.

For Example
A $20,000 loan is made with an interest rate of 9 percent per year. Payments are based on amortization schedule of 30 years, but the loan has a term of only five years. The 30-year amortization schedule keeps the payments affordable at $162.92 per month. However, after five years, the borrower would have to pay off the entire outstanding principal balance of about $19,176 in one lump-sum balloon payment. This could be described as a 360/60 loan, indicating payments based on 360 months of amortization with a term of only 60 months. It could also be described as a 30/5 loan, indicating a term of five years with 30-year amortization.

Negative Amortization

If periodic installment payments on a loan are insufficient to pay all of the interest due, the unpaid interest is added to the principal, causing the loan balance to increase rather than decrease. This is called negative amortization.

Negative amortization may occur when the loan is:

  • a graduated-payment mortgage (GPM). In a GPM, payments start at a level that does not pay all of the interest being charged, so the unpaid interest is added to the loan balance, causing negative amortization. The payments gradually increase in scheduled amounts at scheduled times until they finally level out at the amount needed to amortize the loan over the remainder of the loan term.
  • an ARM with a payment cap. This loan allows a borrower to make payments that do not cover all of the interest being charged, while the lender adds unpaid interest to the outstanding loan balance.
  • an option ARM, or payment-option ARM, which gives the borrower options to make payments to amortize the loan over 15 years or 30 years, to pay interest-only for a period, or to make minimum payments. Payments under the minimum payment option (negative amortization, deferred interest) will not pay all the interest being charged, so the unpaid interest is added to the loan balance. (This type of loan is no longer generally available.)
  • a reverse mortgage, or reverse annuity mortgage. This loan has a balance that increases as loan proceeds are disbursed to the borrower and as interest is added to the balance.

Interest-Only Loans

An interest-only mortgage, also called a term or a straight mortgage, provides for no amortization during the term of the loan. The principal is repaid at the end of the loan term through a balloon payment. Some interest-only loans are really combination loans, as they have an initial period during which payments are interest-only followed by a period of substantially higher payments amortizing the loan for the remainder of the loan term.

Construction Loans

Construction financing is one of the  types of mortgage loans and is high-interest interim (or temporary) financing that serves to finance the cost of labor and materials used during construction. It extends from the start to the completion of the work, when it is then paid off, often with the proceeds of a more permanent form of financing (a take-out loan).

At the time a construction mortgage is created, the building that is pledged as part of the collateral for the loan does not exist, so only the land value is available as collateral. Generally, the lender wants the loan to be a first mortgage on the property. This means that either the land must be free of liens or the existing liens must be subordinated to the construction loan.

The loan is generally an open-end mortgage or a line of credit, in which the lender commits to lending (or authorizes) a certain amount, usually around 75 percent of the expected value of the property after the work has been completed. However, the lender does not initially release the full loan amount. Instead, it provides advances, or draws, as work is completed. If the mortgage provides for obligatory future advances (i.e., advances that must be provided if certain conditions are met by the borrower), those advances have priority over intervening liens.

The lender may withhold the final release of funds until the building inspector issues a certificate of completion and:

  • the lien period has expired, to ensure no liens are filed against the property for unpaid work; or
  • all labor and materials have been paid for, as evidenced by lien waivers from each of the contractors and subcontractors on the job.

Interest is charged on the money only as it is disbursed. It is generally repaid in interest-only installments during the loan period, although some lenders will allow interest to be repaid in a lump sum after the work is complete. In either case, the entire loan amount is due in full within a short period after completion of the work.
Permanent construction loans or construction-to-permanent loans which are  types of mortgage loans for investors may be made to owner-occupants and developers. Fannie Mae’s construction-to-permanent mortgage is a 15- or 30-year loan that can be used to finance construction of one- or two-unit owner-occupied homes, one-unit second homes, or investor homes. The loan amount may be up to 95 percent of the construction cost or the value of the property upon completion of construction, and the funds may be used to purchase the land for the home.

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