Loan Types

With foreclosures at an all-time high, sub-prime loans and Alt-A loans are all but extinct as we have returned to a more traditional time of lending. Gone, too, are all of the exotic bells and whistles that accompanied those loans. What remains are the basics:

Government Loans
Conventional Loans
Construction Loans

The interest rate for most loan types is either locked in for the life of the loan or for a specific amount of time, after which it can adjust. These two programs are known as Fixed and Adjustable.

Fixed Rate Mortgage

With a fixed rate mortgage, you know exactly what your principal and interest payment will be each month for the life of your loan. It won’t change because your interest rate doesn’t change. The tax and insurance component of your payment (escrow) can change, and probably will, if your taxes and insurance change. Unfortunately, there’s no way to lock those in. If interest rates go up, you’re protected with a fixed rate mortgage. Conversely, you won’t benefit if rates go down. You can always take advantage of falling rates by refinancing.

Fixed rate mortgages might be your choice if you:

Want or need the security of a fixed payment.
Think that interest rates will go up.
Are on a fixed or limited budget.

Adjustable Rate Mortgage (ARM)

Compared to fixed rate mortgages, Adjustable Rate Mortgages (ARMs) offer a lower interest rate to start, so your monthly payments are generally lower. ARMs have an initial fixed rate period where the interest rate doesn’t change followed by the rest of the loan’s lifetime period where the rate is adjusted at predetermined intervals. At each of these intervals the interest rate moves up and down with the market, and the adjustments are based on an "index." The most common indices used in ARMs are U.S. Treasury Bills and the London Interbank Offered Rate (LIBOR). Also contributing to the rise or fall of your interest rate are caps and margins. Caps limit how much your interest rate can change per interval and over the life of the loan, while the margin is added to the index to determine the new rate.

Fixed rate mortgages typically carry a slightly higher interest rate as it acts as insurance that the rate will not move higher. For this reason, an ARM may make sense when you don't believe that you will need that insurance. For example, if you know that you will move in three years, why would you pay for 27 years worth of insurance (30 year fixed mortgage) that you are never going to use, especially when you can use an ARM and get a lower monthly payment? An ARM should NOT be used to qualify for more home!

Government Loans

FHA - The Federal Housing Administration (FHA) provides a loan guarantee program instead of the standard private mortgage insurance (PMI) so qualified borrowers can get a mortgage loan with a down payment as low as 3%. The FHA doesn’t make the loan but rather they guarantee the loan minimizing the lender’s financial risk. FHA loans usually offer fairly liberal qualifying criteria compared to Fannie Mae and Freddie Mac and involve small down payments.

VA - The Veteran's Administration (VA) provides a loan guarantee program for qualifying veterans of the United States military. Under this program, the veteran has no monthly mortgage insurance. More importantly, there is no down payment requirement! Like an FHA loan, VA doesn’t make the loan but rather they guarantee the loan minimizing the lender’s financial risk. Also like FHA loans, they usually offer fairly liberal qualifying criteria for both fixed and adjustable loans. It is a fantastic way that the United States says "thank you" to its military for their service to our great nation.

USDA - The United States Department of Agriculture (USDA) Rural Development program, like FHA and VA loans, guarantees loans made by lenders. The loan is geared toward rural communities, and its biggest advantage is that there is no requirement for a down payment. There are, however, strict guidelines as it relates to the geographical location of the home and the income of the household.

Conventional Loans

Conventional loans are, essentially, all loans that are not insured by FHA, VA, or USDA. These loans, if required, are insured using private mortgage insurance. There are two types:

Conforming - Conforming loans are called this because they conform to the requirements and loan limits as set forth by the government sponsored enterprises (GSE) of Fannie Mae and Freddie Mac. They must conform in this manner because they are bought and sold on the secondary market.

Non-Conforming - Also called Jumbo Loans, these loans conform to the requirements of the GSE's with the exception of the loan amount. Currently, loans in excess of $417,000 are considered non-conforming (except in certain locations of the country where the cost of living is much higher).

Construction

Construction loans (also known as interim financing) are used to finance the building of a new home rather than purchase an existing home. They are usually variable-rate loans that have interest only payments during the construction phase. Draws are scheduled based on the stages of construction to pay the builders.

Once construction is complete, the construction loan is converted to a normal mortgage by way of a construction-to-permanent loan which is also know as an end loan or a take-out loan.