The Types of Home Loans Available to Homeowners and Home Buyers
There are really not as many home loan products available for current home owners or those seeking to buy a home with a mortgage as people believe there are. Basically there are two types of loans: fixed rate and adjustable rate. Fixed rate mortgages are almost always for 30 year amortization terms (360 months) with equal payments each month for the entire term. Homeowners or home buyers can also get 15 year terms, and in some cases 40 year terms. Adjustable rate mortgages (ARMs) come in more flavors. You can get a pure monthly adjustable or yearly adjustable mortgage, or you can get a fixed rate for a specific number of years after which the loan goes adjustable.
Lets examine adjustable rate mortgages first. These are the most common types of home loans available these days because they are usually the most affordable for home buyers and come with the lowest rates. Adjustable rate home loans are exactly what the title implies, that is, adjustable. The interest rate that determines the amount of interest that the borrower pays over time adjusts, usually on a monthly basis.
The interest rate of the loan is tied to an index. There are several indexes that are used by banks and lending institutions to determine the interest rates they offer to customers. Indexes vary wildly and you need to check the performance history of the index rate that is being tied to your loan carefully or else you could be buying into a loan that could adjust higher very quickly. The most common indexes used are the LIBOR (London Interbank), Prime, COFI (Cost of Funds), or COSI. The actual interest rate that is given to the borrower is a spread from the actual index amount. For instance if the index is at 3% and the spread is 3%, then the borrowers actual interest rate is 6%.
An important thing to remember about these types of home loans is that even if the broker tells you that this is a No Fee loan, they are making money off the spread. The larger the spread, the higher the rebate, or yield spread premium that the lending institution or bank pays the broker. Most of the time the broker has to disclose the amount of the yield spread premium that they are getting from the bank, but not always. There are loopholes. The best way is to ask them directly how much they are making on your loan and then try and negotiate it down. The broker has to make some money, but they should not get rich off of your deal.
All of these types of home loans have a cap which the loan cannot be adjusted higher than. For instance, if a loan has a cap of .25% monthly, and the starting rate is 5%, then no matter what the index does, the adjusted rate the following month cannot be higher than 5.25%. Most ARMs have yearly caps as well. Consumers need to check these caps carefully and insist on the lowest ones.