Home > Types of Mortgages
What is a Mortgage?
Technically speaking, a mortgage is a way to use real property as a security for the payment of a debt.
Basically speaking, a mortgage is a loan for something tangible, like a house, that the creditor (usually a bank) can take from you if you fail to pay back the debt. When Americans speak of "mortgages" they are usually talking about home mortgage loans.
There are actually many types of mortgage loans, but some of them are just weird and uncommon, so we won't discuss every type here today. We will stick with those mortgage types which are relevant to home buying and home loan refinancing.
Also known as a Fixed-Rate Mortgage, a conventional mortgage is a mortgage loan with an interest rate that does not change during the entire term of the loan. Conventional mortgages are generally not insured or guaranteed by the government in the way that FHA loans are.
A mortgage is considered "jumbo" when the loan amount is greater than the industry standard definition of a conventional mortgage. This type of mortgage is used when agency limits (see: FNMA and FHLMC) are less than the full loan amount. This basically means that Fannie Mae and Freddie Mac won't purchase the entire loan, and banks or insurance companies must step in to fill the gap. This is, really, no big deal for the borrower. If you can afford to buy a house that exceeds the conventional limits (usually $417,000), your mortgage broker will just get you the jumbo loan--there is no need to further qualify.
Just like it sounds, interest-only means that the borrower will pay just interest costs on the loan for the first five or ten years, while the principal balance stays the same. After the interest-only period has expired, the borrower will begin paying towards the principal for the remainder of the mortgage term. It might sound like a bad idea, but interest-only mortgages have advantages. For example, if the borrower has a career job that will increase in pay over time, it may make sense to enter into this type of home loan so that payments are small at first, then grow later when the borrower gets a raise or moves higher in her career.
While interest-only loans have their place, the recently popular ARM loans (adjustable rate mortgage) aren't always such a good deal. ARM loans require an interest rate adjustment after the interest-only period has ended, which is kind of like forcing a refinance after five or ten years. It may not be a good time to get a new interest rate, and the new rate may actually increase payments substantially, depending on the economic climate at the time. This type of mortgage loan is partially responsible for the 2008 US economic recession.
Basically a regular mortgage that also includes personal property, such as vehicles, furnishings, or major appliances. Large estates are sometimes sold as packages, and so require more complex mortgages to value the additional properties and underwrite the loan.
Not very common in residential mortgages these days, balloon loans involve making payments during the life of a short-term loan (sometimes only 7 years), but still having some principal left over at the end. This extra balance due at the end of the loan term requires a "balloon payment," or a very large lump payment of the sum of the remaining mortgage balance. This makes more sense in commercial property mortgages because, ideally, the borrower has generated enough income from the property to cover this final payment. However, in many cases, the final amount can be "reset," or simple refinanced, if the borrower cannot make that last balloon payment.
In residential purchases, occasionally a deal will be made requiring annual balloon payments. This was more common in the 1980s when lending standards were decreased slightly to sell more homes to promising business people.
The Federal Housing Administration insures these loans for qualifying families and individuals under certain conditions. This type of mortgage is for first time home buyers and otherwise risky borrowers. The FHA has its own qualification process, and they offer much assistance to the qualified buyer. FHA loans are insured by the federal government, and can be very helpful to many Americans, including low-income families or first time buyers will no down payment savings. There are even federal grants available through the FHA designed to cover down payments and closing costs.
Graduated Payment Mortgage
This type of loan, called a GPM, has low initial payments for the first 5-15 years, then increases each year until the end of the loan. It is usually only used for young professionals, such as doctors just out of med school, who cannot afford large payments now but will likely be able to afford bigger payments later. This way, a starting doctor or rocket scientist can still buy a big house based on future plans to earn greater salary amounts as his/her career progresses. This is not a popular loan type.
For senior citizens with little or no retirement savings, this loan type basically involves selling a home (or the equity therein) on a payment plan to expire when the owner dies, sells the home, or moves out. This way, the home owner essentially receives payments towards the home while still being able to live in it, so it basically turns the equity into a kind of retirement account.
Also referred to as a home equity line of credit, or HELOC, an equity loan generally involves a new mortgage being placed on real estate in exchange for cash paid to the borrower. So, if you have $50,000 worth of equity in your home, you can probably find a bank to agree to front you that $50,000 in exchange for part of your home. You must then make monthly payments to the mortgage until it is paid off. Equity loans usually have higher interest rates (especially equity credit lines), and are not usually a good idea unless the value of the property has increased greatly since purchase, and the primary mortgage has already been paid off.
Equity loans are sometimes bundled with conventional or jumbo mortgages. For example, just before the 2008 recession, lenders were financing home purchases with 80/20 loans. This means that 80% of the property value was financed with a conventional or jumbo mortgage, and the other 20% is covered with an equity line of credit from the same lender. This means that 100% of the home was financed by the lender, and that equity loan was maxed out at the beginning. This means the buyer would need to make two payments each month, one to each loan. While probably not a great idea, it did work for a few people who had no down payment but could afford both monthly payments. However, this kind of liberal lending practice is considered to be at least partially responsible for the 2008 US recession.