Are you interested in getting a mortgage? A mortgage is a debt used to buy an asset or property, such as a home, plot of land, or real estate. The borrower promises to pay the lender based on the agreement over a certain period. The regular payments are divided into interest and principal. The property becomes a guarantee for the lender.
To apply for it, the borrower should meet the requirements set by the company, including a credit score or Down Payment (DP). Besides, you also have to learn about the types of home loans first to choose the right one that fits your needs. Here are the types of mortgages for real estate that you should learn before applying.
Types of Mortgage and How it Works
1. Fixed Rate
The first type of mortgage is a fixed-rate financial product that has the same interest rate for the whole life. It makes you pay for a monthly payment that consists of the interest and principal. It usually comes in 15 or 30 years, even though some companies offer flexible term periods.
Before applying, it’s better to learn the pros and cons so you know what to prepare in the future. This type has fixed monthly payments and is easier to budget for. However, the rates are sometimes higher than introductory rates on adjustable-rate debt. You also need to refinance so you have a lower rate.
2. Adjustable-rate
The adjustable-rate provides a rate that changes as time passes. Some companies offer a lower or fixed introductory rate for a specific period. After the period ends, the rate becomes variable, it can go up or down. It also doesn’t change randomly but it adjusts at set intervals. It is influenced by the economic conditions every six months until it’s paid.
ARMs are likely to have lower introductory rates and might be lower if the general level of interest rates in the market falls. Unfortunately, it also has an ongoing risk of higher monthly payments. So, it makes it harder for you to plan your budget as the rate changes over time. That is why an adjustable-rate product is suitable for those who don’t plan to live in the house.
3. Interest Only Loans
Another type is interest-only and payment-option ARMs. This option is quite complex and risky so it’s the proper choice for people who understand finances or experienced ones. It is because it has unexpected large payments at the end. In the early 2000s housing crisis, many people lost their homes due to interest-only loans.
4. Reverse
Are you 62 years or older? Reverse is the best decision you can apply for to borrow against your equity in a property. You also get tax-free payments from the servicer. Plus, it’s not a must for you to pay monthly. It is repaid if you’ve successfully sold the house, moved out permanently, or passed away. It’s paid back from the home’s price when you don’t need it anymore.
5. Variable Rate
This type of rate is real estate debt without a fixed interest rate. The payment fluctuates based on a benchmark or reference rate, such as the Prime Rate with +2%. Lenders offer fully variable-rate and hybrid ARMs. The hybrid ones consist of an initial fixed period followed by a variable rate that starts with a fixed rate and switches to a changing rate.
6. Blended
Just like the name, a blended mortgage adjusts your current interest rate. You maintain your existing one, but the interest is adjusted to a point between the lower rates currently and what you’re paying. It also allows you to have equity in your home before the current term is over.
7. Conventional
Conventional or high-ratio is the type of debt that is available in two forms, conforming and non-conforming. The conforming ones are set up by specific rules from the government. It covers things like your credit score and the debt amount. If the debt fulfills the requirements, the major players in the market will buy it.
When you have a DP of less than 20 percent, it’s called a high mortgage. It is only available for homes of $1 million or under. Because they are insured, the rates tend to be lower than conventional low-ratio ones. This type is riskier for the lender. It’s not free, so you have to pay the premiums based on the loan-to-value ratio.
8. Open
If you want to avoid the triggering prepayment penalty, you can choose open financing. It allows you to increase your regular purchases and add lump-sum payments whenever you like. It makes your amortization period shorter and saves you more money. However, it has a lot of costs since the rates can fluctuate higher than the closed ones.
9. Closed
With closed financing, you only have to pay the penalty If you want to change the terms and conditions. This debt locks your terms and you can pay It without any fees. You can freely choose the duration or period you’re locked in your contract. Sometimes, it ranges from 5 months to 10 years.
There are prepayment penalties for closed products that you need to pay attention to. Breaking the contract will cost you the remaining interest, accumulated via IRD. The penalty amount leads to higher penalties. If you break it, low rates lead to high penalties that help lenders recover lost income and keep the rates low.
10. Convertible
The benefits of a convertible mortgage are almost the same as a closed term. Sometimes, it confuses the borrower to decide one of them. If you need a longer period, convertible products can be closed at any time without prepayment charges. It usually has a 6-month term. Most companies offer a 6-month term either at a fixed or variable rate.
This finance product offers flexibility to convert your loan or renew it at the end of the term. You can also choose the lending company that offers convertible financing with a DP of lower than 20%. Once the rates decrease during the initial period, you can maximize the chance by saving money and converting to a fixed rate with a lower rate.
Most lenders set penalties for paying off the debt early or breaking it before the end of the term. However, convertible financing doesn’t have these penalties, so it gives more space and flexibility to the borrowers. If you are still not sure about applying for it, you can have a professional agent to discuss whether your conditions need it.
11. Collateral
Need extra funds? Collateral financing is the best choice for you to have more than the amount required to buy an asset. The extra funds can be used for any house needs in the future. It is the same as home equity lines of credit. Both are set up at the same time as your initial one.
12. Cash-back
Cash-back can also be used to have extra funds from home purchases. You can use the money to pay for emergency financial needs. With a large benefit, you also have to be aware of the risks. It comes with higher interest rates than other types. It is also available if you choose a fixed-rate loan.
13. Second
This is a type of debt to buy a property or home that has a current loan. For your information, a first mortgage is used to purchase a home, while the second one is to borrow against your home’s equity. The interest rate of second home debt is higher and the borrower only gets less money than the first one.
14. Subprime
Do you have bad credit? You don’t need to worry because there is a type of mortgage that is the perfect choice for bad credit borrowers with scores of 680 or below. People with a negative credit history in the past, like bankruptcy might also consider it. With higher risks for lenders, they set the rates higher and bigger DP.
15. B Lender
There are two kinds of lender servicers. The first one is the servicers who are for the borrowers with good credit and traditional income, while the second one provides financial products to everyone else. Aside from a bad credit score, the company also helps self-employed people with limited credit history who face difficulties in protecting their loans.
16. Rent to Own
Rent to own isn’t included as a type of loan, but a way that buyers can prepare for financial products a few years from now. You can agree to pay DP and above-market rent for certain years. In the final stage, you become a homeowner by purchasing your rental property. It sounds riskier and should be considered before taking it.
17. Tenants-in-common
Plan to buy a property together with your partner? Tenants in common financing is the right option. It accumulates how much each party’s share of the property and the allocation of payment duties. It’s suitable for those who want to build a new life or business together.
18. Joint Tenancy
Similar to tenants in common items, a joint tenancy is for multiple buyers who are responsible for the payments. However, there are several differences that you should take a look at. Joint tenancy comes with equal ownership of the home so both parties are responsible for paying an equal share. If one of the parties dies, the share of the home goes to the other party.
19. Private
Mortgages are also categorized by other unique factor, such as private ones. This home loan is for the buyers offered by both individuals and institutions. It is for the buyers who can’t have approval from a bank or other lenders. The regulation is not as heavy as the traditional one, but you have to be careful of choosing a private lender.
20. Halal
Since Sharia law prohibits charges of interest, traditional lending is forbidden for Muslims. To meet their needs, some lenders offer halal products. There are three shariah-compliant products, including Musharaka, Murabaha, and Ijara. Every one of them has a different term, method, and structure for the ownership.
21. Vendor Take-Back
Vendor Take-Back or VTB requires you to pay the seller instead of a traditional third-party servicer, so it gives flexibility to close the deal. In most cases, it becomes a source of cash flow for the sellers. However, note that VTB might be risky if the buyers are not in a stable financial position.
22. Investment Property
Mortgages make it harder for buyers to purchase a rental property. DP requirements are often higher and the servicer will calculate the property according to its rental and resale chance. The rental income will be added to your earnings, so you can borrow a larger amount of money for your debt.
23. Construction
Need some help to pay for a real estate you build? Construction financial products help you to contract a builder to complete the construction for you. It isn’t equipped with a full loan. You get a certain percentage of the debt, called a draw. When your home is ready to use, you will switch from a construction product to a traditional one.
24. Bridge Loans
A bridge loan is a short-term financial product so you can switch from a sold property to a recently purchased one. Purchasing a new house before selling it creates financial struggles. It can assist with the associated closing and moving expenses. If the previous house is sold, use some of the money to pay the bridge debt.
25. Condo
A condo mortgage is a standard home loan but not a specialized product. The company has to consider it first before setting condo maintenance fees. The lender uses your debt service ratios, credit scores, and potential housing costs. It also includes property taxes, utilities, and home loan payments. The lender examines 50 percent of your monthly maintenance costs.
Real estate mortgages come in various kinds and are categorized by additional cash, repayment, interest rate, and DP. Each product has pros and cons that must be considered before applying it. It’s much better to have some help from a professional to determine the end product. Make sure you meet the requirements and it doesn’t bother your financial goals.
