Mortgage Bank

Mortgage Bank
By Steve Faber

It seems there are almost as many different types of mortgage loan products out there as there are mortgage holders. The truth behind many of the mortgage broker’s and banks advertising campaigns is that, for the most part, they all have very similar mortgage products they can offer you. If you aren’t footing the bill, they’re passing it along to someone else, rolling it into your mortgage (so you can pay interest on it for 15 or 30 years), or upping the mortgage interest rate you’ll pay so they can cover those costs.

Fixed Rate Mortgage

The most basic, and the one that’s been with us the longest, is the fixed rate mortgage. As the name suggests, a fixed rate mortgage has the same interest rate for the term of the loan, usually 15 or 30 years. Typically you’ll get a lower interest rate on the 15-year mortgage, reflecting the lower risk the lender associates with a shorter-term obligation. The problem is that, with these longer terms, you’ll pay a higher interest rate, and pay it for a longer term. The upshot is that you’ll pay substantially more in total interest with these longer-term mortgages.

Adjustable Rate Mortgage

The other type of mortgage many people are familiar with is the adjustable rate mortgage, normally referred to as an ARM. The index is usually the London InterBank Offered Rate (LIBOR) or the US Fed discount rate. The first number is the length of the initial interest rate; the second number is how often the rate will be adjusted thereafter.

An adjustable rate product is good for those that won’t be living in their home for very long, and can take advantage of the lower rate during their stay. In many cases people initially take an ARM, then refinance to a fixed rate product before the rate adjusts upward.

Option ARM

A newer mortgage product that’s beginning to enjoy some popularity is a variation of the ARM called the option ARM. As you might assume from the name, the option ARM allows borrowers to choose between different payment options. These are based upon a fixed term mortgage payment, an ARM payment, or an interest only payment. In many cases these loans have very low initial payments. As with a traditional ARM, the lower payment can help borrowers to simply afford a home in expensive areas, or a nicer home than they could otherwise. The initial interest rate of an option ARM tends to be even lower than a traditional ARM.

These mortgages can be advantageous for borrowers that have uneven cash flow situations, such as commission sales people, business owners, or seasonal workers. If the negative amortization reaches a certain point, termed the “recast cap”, the mortgage reverts to a fixed rate loan with payments sufficient to amortize the entire loan.