The Basics of Real Estate Mortgages

Mortgages are loans that are used to purchase real estate and come in many different forms. The most common mortgages are Conventional, FHA and VA. Other types are Second Mortgages, Reverse Mortgages and Balloon Mortgages. Mortgages often involve the use of Discount Points.

Conventional Loans

The conventional loan is the most common type of mortgage used in the nation today. Conventional mortgages are loans between borrowers and lenders that aren't insured by the government. Conventional mortgages are either privately insured through private mortgage insurance companies or not insured at all. Conventional loan guidelines typically require a minimum down payment of five percent on owner-occupied (non-rental) properties. For mortgages that have a down payment of less than 20%, private mortgage insurance (PMI) is usually required. Most conventional mortgages have time frames of 15 to 30 years and may be either fixed-rate or adjustable.

Fixed rate mortgages mean that the interest is permanently "fixed" at the rate available when the mortgage was created. The interest rate never changes no matter what interest rates do later. Fixed rate loans provide a level principal and interest payment that a borrower can depend on and are especially attractive when rates are low.

Adjustable rate mortgages mean that during the first few years, the interest rate will be lower than a typical fixed rate loan but will increase (adjust) upward to rates that are prevalent at a later date. Adjustable rate mortgages are normally used only when the borrower cannot currently qualify for the normal fixed rate interest level, but anticipates a larger income in the near future. The risk for the borrower is if that extra income does not materialize or if other expenses occur later on that cause the adjusted rate to not be affordable.

FHA Loans

FHA mortgages are insured by the Federal Housing Administration, which is a division of HUD. The program was created in 1934 to stimulate the housing market during the Depression. FHA loans are insured by the government against default, but the mortgages themselves are made by major private lenders and are usually sold to investors as mortgage-backed securities by the federal housing finance agency Ginnie Mae. FHA loans are available from most of the same lenders who offer conventional loans. FHA maximum mortgage amounts are limited, and the maximum loan amount varies among geographic regions. FHA mortgages are usually on a fixed-rate mortgage with terms of up to thirty years. FHA can lend up to 97% of the home value, and can be refinanced any time without a pre-payment penalty, and without having to qualify all over again. FHA insurance makes it possible for private lenders to provide mortgages to lower income families without attaching the rates and fees that sub-prime lenders do. FHA-insured loans have become an important element in the proposed solutions to the subprime mortgage crisis.

VA Loans

VA mortgage loans are loans insured by the Department of Veterans Affairs. The program was created in 1944 during World War 2 to assist returning military personnel in buying a home. VA mortgages are reserved for those who have served in the military or are currently in the military in active or reserve status. They are also available to qualified surviving spouses. VA loan guaranty is only for owner occupied properties, which can include homes, condominiums, townhomes, 2-4 family properties and manufactured homes, as long as it is owner occupied at least in part. By example, the applicant can obtain a mortgage for a duplex, live in one side and rent out the other side. VA mortgages offer the qualified veteran or active duty military person an opportunity to buy a home up to a specified amount with no down payment and do not require Private Mortgage Insurance (PMI). Like FHA mortgages, VA places a limit on the maximum mortgage amount. VA determines your eligibility and, if you are qualified, VA will issue you a certificate of eligibility to be used in applying for a loan.

Balloon Mortgages

A Balloon mortgage is a loan that is usually a short-term fixed-rate loan with even monthly payments amortized over a stated term, but provides for a lump sum payment to be due at the end of a specified term. These mortgages can be used as either a first or second mortgage. The nature of ballon mortgages is that the principal is not paid off entirely during its term and the monthly payments are often lower than they would be in a fixed rate mortgage. Balloon mortgages are often used as a type of Second mortgage, especially when a borrower is seeking the lowest possible monthly payment in the short run. These mortgages carry an inherent risk for the borrower because that large lump sum becomes due and payable at the end of the term, so these mortgages should be used with extreme caution.

Reverse Mortgages

Reverse mortgages are becoming popular in America. Reverse mortgages were designed only a few years ago and were made to help people who have retired and stopped working, but still have to make monthly mortgage payments. They are a special type of home loan that lets a homeowner convert the equity in his/her home into cash. Reverse mortgages can be relatively complex, and their use should be considered carefully by the borrower. Reverse mortgages have been around for a long time, but it wasn't until the early 1990s that they began earning respectability after the Federal Housing Administration began insuring reverse mortgages for repayment to lenders.

Second Mortgages

These are used when a borrower needs additional financing to buy a home. Second mortgages are subordinate, meaning that in the event of default, the primary, or first mortgage would get paid off first, and then any funds remaining would be used to pay off any second mortgages. Second mortgages are also arranged for various purposes, such as financing home improvements, college tuition fees, debt consolidation or other emergency expenses. Second mortgages are available as either fixed-rate loans, or adjustable-rate home equity lines of credit. Second mortgages are based on the market value of the home minus the balance of the first mortgage. Second mortgages terms are are typically shorter than the primary term and are commonly written at a higher rate of interest, due to the inherent risk of the loan. An advantage for the borrower is that the interest paid on a second mortgage is tax deductable, whereas payments for PMI are not.

Discount Points

Discount Points are used to buy your interest rate lower and are charged as a percentage of the loan amount. Discount points are entirely optional unless they are required for you to qualify for the loan payment, due to a lower than required income or higher than expected expenses. Discount points are paid in cash at closing and are typically charged to the seller. A common arrangement is that when discount points are charged, the seller will want to increase the price of the home to cover this expense. The result is that 80% or more of the discount point cost is actually financed by the buyer. Discount points are not to be confused with an origination or broker fee and are tax deductibleonly for the year in whichthey were paid.

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