Mortgage Loan Basic Terms You Must Know
When you intend to take a home loan for the first time, you will find mortgage-loan and finance terms that you are not familiar with. Well, in this article I will take you through basic terms of mortgage – loan, the meaning, types and their application.
Conforming Loan Limits
First thing you need to understand is loan limits. If your mortgage loan amount exceeds a specific amount, known as “conforming loan limit”, it is considered a jumbo loan which holds interest rate. The limit typically changes each year and differentiated by counties and location (high cost areas).
Loan limits for mortgages originated in 2009 are set under the provisions of the American Recovery and Reinvestment Act of 2009. Learn more about Conforming Loan Limit at Official site of Federal Housing Finance Agency here.
Fixed Loans
- 30 Year Fixed Mortgage Rates
This loan program is fixed for 30 years. Your interest rate will not change for 30 years. This is ideal for people who plan to stay at their present property for a long period of time.
- 20 Year Fixed Mortgage Rates
Fixed for 20 years. Your payment will be higher than 30 year fixed loan because of the shorter loan period. Interest rate will not change for 20 years.
- 15 Year Fixed Mortgage Rates
15 year fixed loan has a loan term of 15 years and will not change during this period. Your monthly payment on this loan program will be much higher than 20 years fixed or 30 years fixed. Use this loan program if you plan to sell your home in 5-8 years. Interest rate will not change for 15 years.
Adjustable Rate Mortgage (ARM)
ARM Loans are fixed for a certain period of time, where after that period ARM loan becomes an adjustable loan. How do they work?
Each ARM Loan Program has the following options:
- Index: Most common index-LIBOR
- Margin: Is given to you by your lender, and it is the difference between the index rate and the interest charged to the borrower
For example 5/1 ARM. This loan is fixed for 5 years after which in 6th year it becomes an adjustable loan. Your loan officer will tell you what your index is and what your margin is. Usually 5/1 arm is tied to 1-year treasury index and margin is around 2.00%-3.00%
Your index + margin = Fully Index rate. Your new note rate (interest rate) after 5th year.
What about the 6th year? What would your payment be?
Let’s say that your loan officer told you that your margin is 2.5% with 1 year treasury index. You will have to look up 1 year treasury index for a specific month.
Say 1 year treasury as of August 2009 is 4.7%, and you know that your margin is 2.5%. Therefore you new interest rate is 1 year treasury 4.7% (index) + 2.5% (margin) = 7.2% for the beginning of 6th year.
Index rate are move on monthly basis, therefore your payment may fluctuate each month. In most cases banks wills end you a statement advising you that your rate will change.
- To protect consumers from high index rates, lenders implemented a CAPS.
An example of this is a 2/6 cap, which allows the interest rate on your ARM loan to go up or down by no more than two percent every adjustment period, and has a total limit of six percent for cumulative changes. Therefore a 2/6 cap on a 5% ARM will allow a maximum rate (6 + 5%) of no more than 11%.
In some cases you will see 2/2/6, which means 2% adjustment with 2-year prepayment penalty and total of six percent of cumulative changes.
- With an ARM you can have either a fixed rate or you can choose an Interest Only structure loan.
1/1 ARM Mortgage Rates – 1 year ARM (Adjustable Rate Mortgage) is fixed for 1 year and in 2nd year it becomes an adjustable.
3/1 ARM Mortgage Rates – 3 year ARM (Adjustable Rate Mortgage) is fixed for 3 years and in 4th year it becomes an adjustable.
5/1 ARM Mortgage Rates – 5 year ARM (Adjustable Rate Mortgage) is fixed for 5 years and in 6th year it becomes an adjustable.
7/1 ARM Mortgage Rates – 7 year ARM (Adjustable Rate Mortgage) is fixed for 7 years and in 8th year it becomes an adjustable.
10/1 ARM Mortgage Rates – 10 year ARM (Adjustable Rate Mortgage) is fixed for 10 years and in 11th year it becomes an adjustable.
Interest Only Loans
For example, if a 30-year fixed-rate loan of $100,000 at 8.5% is interest only, the payment is .085/12 times $100,000, or $708.34. This is an example of interest only payment.
Each loan payment consists of Interest and Principal. Here you will be paying an interest each month and your principal will be adding to your balance, thus increasing it. You may also pay both principal and interest.
If a lender offers you an Interest only Loan these loans are tied to an index just like ARM loans.
MTA Index
The MTA index generally fluctuates slightly more than the COFI, although its movements track each other very closely.
- 1 Month MTA ARM Mortgage Rates
- 3 Month MTA ARM Mortgage Rates
- 6 Month MTA ARM Mortgage Rates
- 12 Month MTA ARM Mortgage Rates
COFI Index
This index rise (and fall) more slowly than rates in general, which is good for you if rates are rising but not good for you if rates are falling.
- 1 Month COFI ARM Mortgage Rates
- 3 Month COFI ARM Mortgage Rates
LIBOR Index
LIBOR is an international index, which follows the world economic condition. It allows international investors to match their cost of lending to their cost of funds. The LIBOR compares most closely to the CMT index and is more open to quick and wide fluctuations than the COFI.
- 6 Month LIBOR ARM Mortgage Rates
- 12 Month LIBOR ARM Mortgage Rates
Pay Option ARM Loan
Pay Option ARM in a new loan program allowing customers to choose from up to 4 different payments. This loan program is part of an ARM, but with added flexibility of making one of the 4 payments.
Your initial start rate varies from 1.000% to anywhere around 4.000%. The initial start rate is held only for one month, after that interest rate changes monthly.
Four major options are:
1) Minimum payment: For the first 12 months interest rate is calculated using the start rate after that interest rate is calculated annually.
For example, if payment cap is 7.5%, the Option ARM’s 7.5% payment cap limits how much the payment can increase or decrease each year, except for every fifth year (beginning in the 10th year on certain programs), when the cap does not apply. In the event your balance exceeds your original loan amount by 125% (110% in N.Y.), the payment amount may change more frequently without regard to the payment cap.
Because you are paying “minimum payment” this option will defer a payment of an interest which will be added to your balance.
Minimum Payment Adjustment Period: The minimum payment is usually set to 12 months, unless negative amortization limit is reached.
Minimum Payment Cap: This is a limit on how much the minimum payment can change. Your payment cap will be 7.5% for the first five years. On your next payment due, your minimum payment cannot increase or decrease more than 7.5%. If it does than a loan is recast.
Recast (recasting) or re-calculating your loan is a way of limiting negative amortization (neg-am). Option ARM’s recast every 5 years. When the loan is recast, the payment required to fully amortize the loan over the remaining term becomes the new minimum payment
2) Interest Only Payment: With Interest Only you will avoid deferred interest, because you are paying principal and interest. If you pay only Interest or Principal your loan balance will increase because you are adding either principal payment or interest payment to your loan balance, thus leading towards Neg-Am Loan.
Your payment may change on monthly basis based on ARM index (LIBOR,COFI,MTA).
3) Fully Amortizing 30-Year Payment: It’s calculated each month based on the prior month’s interest rate, loan balance and remaining loan term. When you choose this option, you reduce your principal and pay off your loan on schedule.
4) Fully Amortizing 15-Year Payment: It is calculated from the first payment due date.
Negative Amortization Loan (Neg-Am Loan)
Negative amortization loans calculate two interest rates. The first is called the payment rate the second is the actual interest rate. The true interest rate is calculated as simply the index plus the margin without periodic caps. Borrowers are given a choice of which rate to pay. Thus advertisers of negative amortization loans often refer to these loans as “payment option” loans.
A loan that allows negative amortization means the borrower is allowed to make a monthly mortgage payment that is less than the interest actually owed during that month.
For example, let’s say we have a $300,000 loan with an adjustable rate that’s currently sitting at 5%. Simple interest on this loan is easy to calculate. Multiply the interest rate by the loan amount and you have the annual interest of $10,000. Divide $10,000 by 12 months and the monthly “interest only” payment is $1,250. The formula for your monthly payment for interest only loans: loan balance x interest rates / 12 = monthly payment.
Now, let’s say that there’s a provision in the loan documents that allow the borrower to make a minimum payment based on a “payment rate” of 4%. So your lowest payment would be $1,000 because the “payment rate” is based upon 4%, not the actual interest rate, which is 5%.
So if you make the lowest allowable payment you are actually losing $1,000 in equity. The balance of the loan increases to $301,000.
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