Types of Mortgage Loan Programs

Adjustable Rate Mortgages

Adjustable rate mortgage (ARM) loans are set up for the interest rate to change several times throughout the life of a loan. This can vary depending upon the terms of the contract. The changes normally involve an increase in the loan amount. The buyer will start out with a lower interest rate which in turn means a lower monthly payment and that is what makes this type of loan attractive. When the interest rate increases buyers are usually unhappy about the increase. At this time a buyer may want to refinance and obtain a fixed rate mortgage where the interest and payment stays the same over the life of the loan. A popular ARM is a 5 year adjustable rate mortgage since it insures the lender of a steady amount of funding. Some other types of loans that are available include interest only, balloon payment, graduated payments, fixed rate, and negative amortization.

An adjustable rate mortgage loan will have a certain period of time that the beginning interest rate will apply. The contract contains the specifics about the times when the interest rate will change. There will be limits on exactly how much the interest will go up each time and how many times this will happen. A lender may be able to set up a contract where the option to convert to a fixed rate is possible. Prepayment penalties may apply in this type of situation when an adjustable rate mortgage is paid off earlier than specified in the contract. The penalties are normally based upon a percentage of the total amount financed on the loan.

Graduated Payment Mortgage

People who are looking to have an increase in their salary may choose to take out a graduated payment mortgage (GPM). A GPM loan starts out with low monthly payments and then increases gradually over time. This type of loan is attractive to young people who believe their earning potential will increase. However, buyers often overestimate future earning potential and are often caught in a difficult situation when the increase in earnings does not equal or exceed the amount the mortgage payment increases. A buyer could choose a 5 year ARM because it is similar to a GPM but the interest rate increases are based upon the federal prime rate so they can have a higher increase in comparison.

Interest Only Mortgage

When the buyer needs the payment to be low for a certain period of time they can opt to pay interest only. Interest only loans allow the buyer to pay the interest only and the principal balance does not change while this is taking place. Lenders see this type of loan as a risk because there is a chance that the buyer will become discouraged because the principal balance on the loan does not move so there is no equity being earned. Not building any equity will make it difficult for the buyer to refinance in the future. An adjustable rate mortgage might be preferred over an interest only loan since the interest rate with an ARM will start out much lower in comparison.

Fixed Rate Mortgage

The most popular type of mortgage loan is the fixed interest option. The interest does not change over the life of the loan but stays the same as do the monthly payments. A fixed interest mortgage has a set interest rate that is used over the life of the loan with a fixed payment that when paid down will eventually end in zero with the last payment made. A person can choose from different terms beginning with a 15 year on up to a 30 year contract. Even though fixed interest loans may mean paying more interest in the long run over a 5 year adjustable rate mortgage, buyers usually find comfort in knowing what their monthly payment amount is going to be each month so they can plan accordingly. Prepayment penalties do not usually apply with fixed rate mortgages so refinancing looks more attractive.

Negative Amortization

When the payment is not sufficient enough to cover the interest on the loan a negative amortization occurs. In this type of situation the unpaid interest will accrue and will be added to the principal balance so that the payment increases each month. A buyer's payments can vary dramatically from one month to the next so this is not a very attractive option for someone who lives on a budget.

Balloon Payments

A balloon payment mortgage means making a large payment at the end of the loan so that monthly payments are more affordable throughout the majority of the contract period. Buyers who are planning on refinancing or selling before the large payment is due may opt for this kind of loan. A 5 year adjustable mortgage and a balloon payment option differ in that refinancing may be necessary at the end with a balloon mortgage because the buyer is not able to make the large payment. Primarily a balloon payment option is often used more for commercial properties than with residential properties.

Variable Interest Mortgage

Lower fixed rate interest for the first several years of a mortgage are possible with variable interest mortgages. These are very popular with buyers who know that they will be moving within several years after the contract begins. After the first several years the interest rate changes which in turn affects the payment amount. Variable interest rate options are usually financed for no longer than ten years.