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Understanding Different Loan Products

 
Conventional vs. ARMs

Conventional Mortgage: Any mortgage that is not insured or guaranteed by the federal government. The following is a list of commonly seen conventional mortgage programs:

  • 30 year fixed
  • 20 year fixed
  • 15 year fixed
  • 10 year fixed
Adjustable Rate Mortgage (ARM): A mortgage that permits the lender to adjust its interest rate periodically on the basis of changes in a specific index. Depending on the mortgage program, there may or may not be a "fixed rate" period. The following is a list of commonly seen ARM programs:

  • 10/1 ARM
  • 7/1 ARM
  • 5/1 ARM
  • 3/1 ARM
  • 1/1 ARM
  • 6 month ARM
  • 1 month ARM
  • 12 MTA (Pick-A-Payment)
  • Home Equity Line of Credit (HELOC)

Amortized payments vs. Interest Only

Amortized payment schedule: The loan payment consists of a portion which will be applied to pay the accruing interest on a loan, with the remainder being applied to the principal. Over time, the interest portion decreases as the loan balance decreases, and the amount applied to principal increases so that the loan is paid off (amortized) in the specified time. An amortization schedule is a table which shows how much of each payment will be applied toward principal and how much toward interest over the life of the loan. It also shows the gradual decrease of the loan balance until it reaches zero.

Interest Only payment option: This is when the mortgage consists of an "interest only" payment option for a specified period of time. Depending on the mortgage program, the option time period can vary. In comparison to an amortization schedule where a portion of every payment is applied towards paying back the principle balance of the loan, an interest only payment is computed as a simple interest payment calculation, resulting in minimum payment equal to the "interest only" portion. For example, if a person where to borrow $100,000 at 6 % interest, the following is how the minimum monthly mortgage payment would be calculated:

$100,000 X .06 = $6,000 (minimum interest owed per year)


$6,000 divided by 12 months per year = $500 Interest Only payment due per month


Negative Amortization: Some adjustable rate mortgages allow the interest rate to fluctuate independently of a required minimum payment. If a borrower makes the minimum payment it may not cover all of the interest that would normally be due at the current interest rate. In essence, the borrower is deferring the interest payment, which is why this is called "deferred interest." The deferred interest is added to the balance of the loan and the loan balance grows larger instead of smaller, which is called negative amortization.

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