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Types Of Loans

Section 4 - Chapter 17

The Many Types Of Loans

The following is just to give you an idea about what types of loans may be available, and the advantages or disadvantages. Financing is an industry that is always changing, so you won't find some of these loans where you are, and you will find others not listed here. The bottom line in finding the right loan is to know what your situation is, and look at the real total costs of a loan accordingly.

Basic Mortgage Loan

One of the most basic mortgage loans is a loan for 80% of the purchase price of the home. Of course, this requires that you provide the other 20% for the down payment. For this reason, it has not been a popular loan product in recent years. If, however, you do have 20% for a down payment, this may well be the best loan for you. Other loans that let you buy with less money down often have higher interest or require that you pay mortgage insurance.

Fixed Rate Loans

The various types of loans are either fixed rate or variable rate (also called adjustable rate) loans. Fixed rate means that the interest rate is the same for the life of the loan. This is nice if you plan to stay in the home for more than a few years. The interest rate will be higher than those offered on adjustable rate loans, but it won't change.

ARM: Adjustable Rate Mortgage

These loans are subject to changes in interest rates. The rates are lower than those for fixed rate loans, because the lender gets to pass on any increase in the cost of money to you. The interest rate change is according to some published index. Indexes commonly used include the prime rate, the LIBOR and treasury bills. Rates and monthly payments increase or decrease at intervals determined by the lender (once per year is common). However, the interest rate or the change in the monthly payment amount is usually subject to a cap, so they can't rise too fast. There is also usually a lifetime cap.

Before agreeing to an ARM, be sure that you can still afford the loan if the rate increases to it's maximum rate. These loans make sense if you know you'll be moving within a few years. You'll be saving money on interest at first, and if rates go up, you'll be paying off the loan in any case, before they go much higher than the fixed rate options would have been.

Assumable Mortgage

This is a mortgage loan that can be transferred from a seller to a buyer. Once the loan is assumed by the buyer the seller is no longer responsible for repaying it. There may be a fee and/or a credit package involved in the transfer of an assumable mortgage.

These are not common now. If you can assume a loan, it might mean getting a lower interest rate than you can find elsewhere. Informal assumptions, where the you start making the payments while the loan is actually still in the name of the seller, are common in real estate investing. This can be dangerous, though, because in these cases the lender usually has the right at any time to demand that the loan be paid in full within thirty days. They will do this if they can loan the money out at higher interest.

Balloon Mortgage

These mortgage loans offer low rates for an initial period of time (usually 5, 7, or 10 years). Once that time period elapses, the balance is due or is refinanced by the borrower. Be careful with these. They are sometimes presented as adjustable rate loans, but you have to actually re-qualify to refinance when the balloon becomes due. If interest rates are twice as high when the balloon comes due, you may be forced to default and lose the property.

Biweekly Mortgage:

This is a mortgage loan with payments every two weeks. These were fashionable for a while as a way to pay down the loan balance more quickly. Paying half of what the monthly payment might be, you pay more often, so you save a little on interest. You also pay twenty-six payments per year, which is more than the twelve monthly payments would be, so you pay the loan more quickly.

Convertible Adjustable-Rate Mortgage

This is a loan that starts as an adjustable rate loan, but allows the borrower to convert it to a fixed-rate mortgage during a specified period of time. It can be difficult to compare this to other loans, because of the potential but uncertain changes that are possible.

Conventional Loans

"Conventional" loans are those that are private sector loans - not guaranteed or insured by the U.S. government. Most conventional loans are sold into the secondary market, meaning they must meet the standards that are common there. In other words, the bank doesn't make the rules, but just handles the paperwork. Most of the other loan types listed here are "conventional loans." The exception is "in house" loans or loans that the bank actually holds themselves.

In House Loans

When banks hold there own loans, they can make their own rules (within the law). This means they can choose to lend to those who don't qualify for "conventional loans," or choose to forego certain requirements. I once got a mortgage loan without having an appraisal done, for example. If you have trouble getting a loan, find banks that write and hold their own loans. They may be able to help.

Graduated Payment Mortgage

This is a loan that has increasing monthly payments over the term. Payments start lower and gradually rise, usually until year three or five, when they become fixed. The idea is that your income will rise with time, allowing you to afford bigger payments. Initial payments may be interest-only, meaning you won't be paying down the balance of the loan.

Hard Money Loans

These loans are generally for a year or less, and have very high interest rates and fees. Hard money lenders take more risks than banks, and can usually close the loan quickly. They are used especially by investors doing fix-and-flips, who don't mind paying high interest for a short time to make a large profit. The only time this would be an appropriate source of money for a home buyer would be in special circumstances. This could be when you have a great deal on a home, with no other way to finance it, and you know you'll have the money to pay off the loan soon.

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