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loan is a permanent long-term loan that is not FHA- insured or VA-guaranteed. Market rates usually determine the interest rate on the loan. Because of the lack of insurance or guarantee by a government agency, the risk to a lender is greater for a conventional loan than for a non-conventional loan. This risk is usually reflected in higher interest rates and stricter requirements for the down payment and the borrower's income qualification. At the same time, conventional loans allow greater flexibility in fees, rates, and terms than do insured and guaranteed loans
The Federal Housing Administration (FHA) is an agency of the Department of Housing and Urban Development (HUD). It does not lend money, but insures permanent long-term loans made by others. The lender must be approved by the FHA, and the borrower must meet certain FHA qualifications. In addition, the property used to secure the loan must meet FHA standards. The FHA insures that the lender will not suffer significant loss in the case of borrower default. To provide this security, FHA provides insurance and charges the borrower an insurance premium. FHA loans typically have a higher loan-to-value ratio than conventional loans, enabling a borrower to make a smaller down payment.
The Veterans Administration (Department of Veterans Affairs) offers loan guarantees to qualified veterans. The VA, like the FHA, does not lend money except in certain areas where other financing is not generally available. Instead, the VA partially guarantees permanent long-term loans originated by VA-approved lenders on properties that meet VA standards. The VA's guarantee enables lenders to issue loans with higher loan-to-value ratios than would otherwise be possible. The interest rate on a VA-guaranteed loan is usually lower than one on a conventional loan. The borrower does not pay any premium for the loan guarantee, but does pay a VA funding fee at closing.
The US Department of Agriculture Rural Housing Service (RHS) was created in 1994 to meet housing and community development needs of rural America. The RHS has various programs to aid low-to-moderate-income rural residents to purchase, construct, repair, or relocate a dwelling and related facilities. Qualified homebuyers can get loans with minimal closing costs and no down payment.
straight amortized loan
With a straight amortized loan, the borrower pays a different amount with each payment. A fixed amount goes to the principal with each payment. The interest amount changes as the principal balance declines.
fully amortized loan
he borrower has the same payment amount every month. The payment goes first to the interest and then to the principal. Over the life of the loan, the amount going toward interest decreases, while the amount going to principal increases. In the early years of the loan, the principal payment is very small, so it takes several years for the borrowers to increase their equity in the property. However, closer to the end of the repayment period, the borrowers' equity increases much more quickly.
Balloon loans are partially amortized loans. This means that the monthly payments are not large enough to fully amortize the loan by the end of the term, leaving a large final payment due when the loan matures. Many borrowers believe that if they have made payments on time the lender will extend the balloon loan for another term. This could happen, but lenders are not obliged to make an extension and could require the full payment when the note comes due.
Negatively amortized loan
Negative amortization causes the loan balance to increase over the term. This occurs if the borrower's periodic payment is insufficient to cover the interest owed for the period. The lender adds the amount of unpaid interest to the borrower's loan balance. Temporary negative amortization occurs on graduated payment loans, and may occur on an adjustable rate mortgage.
Fixed rate loans
Loans may have fixed or variable rates of interest over the loan term. Conventional loans have traditionally been designed as fixed-rate loans. With this program, the monthly payments for interest and principal never change. Property taxes and homeowners insurance may increase, but generally the monthly payments will be very stable.
Adjustable rate loans
Adjustable rate mortgages (ARMs) allow the lender to change the interest rate at specified intervals and by a specified amount. Federal regulations place limits on incremental interest rate increases and on the total amount by which the rate may be increased over the loan term. The components of an ARM are:
a measure of economic conditions. Some of the most popular ones are the one-year Treasury Bill, the five-year Treasury note, the Cost of Funds Index and the Federal Home Loan Bank average. The lender selects an index and uses that as the starting point for the rate calculation. The interest rate is typically the index plus the margin.
a margin, usually between two percent and three percent, is added to the current index to set the interest rate, providing the lender the desired yield on the loan.
Calculated Rate, or Note Rate
the index plus the margin establishes the calculated rate, or note rate. Since borrowers share the risk with the lender in an ARM, the interest rates tend to be less than fixed rate loans. Further, to increase the marketability of ARMs, lenders often offer a lower initial or "teaser" rate.
a specific time at which the interest rate may change. The adjustment period may be for any period of time but one year, three years and five years are the most common. A multi-year ARM usually converts to a one-year adjustable after the first adjustment period. An ARM is still a 15- or 30- year loan with specific adjustment periods.
Mortgage Payment Adjustment Period
this determines when the lender will change the amount of the monthly payment to reflect the change in the interest rate. Typically, this period corresponds to the interest rate adjustment period. In such a case, the payment will go up when the interest rate goes up. Conversely, if the interest rate goes down, the monthly payment will go down as well.
Interest Rate Caps
to protect borrowers from unlimited increases in the interest rate, lenders establish "rate caps." The first cap (the periodic cap) sets the amount of increase (or decrease) allowed in each adjustment period. The second cap (overall or aggregate cap) sets a maximum interest-rate increase over the life of the loan. A two percent increase in the interest rate results in approximately a 15 percent increase in the monthly payment. These rate caps are also known as ceilings or lifetime caps.
insures a set monthly payment that remains the same although the actual interest rate may fluctuate throughout the year. A common payment cap is 7.5 percent of the initial payment. In this instance a monthly payment of $900 could not vary either up or down by more than $67.50 per month in any one-year period. While this appears to be a good thing, it could be a problem if the payment cap prevents the payment from covering the interest. When that happens, the unpaid interest is added back to the loan, generating even more interest and debt. If this trend continues, the borrower will make many payments but end up owing more that he or she did at the beginning of the loan, creating a negative amortization.
negative Amortization Cap
limits the amount of unpaid interest that the lender can actually add to the principal balance. Usually a negative amortization cap limits the total amount the borrowers can owe to 125% of the original loan amount.
Senior and junior loans
When there are multiple loans on a single property, there is an order of priority in the liens which the mortgages create. The first, or senior, loan generally has priority over any subsequent loans. Second loans are riskier than first loans because the senior lender will be satisfied first in case of default. Therefore, interest rates on second mortgages are generally higher than on first mortgages.
Fixed and graduated payment loans
Loans may have a single fixed payment amount or variable payment amounts over the term of the loan. With a graduated payment mortgage (GPM), the payments at the beginning of the loan term are not sufficient to amortize the loan fully, and unpaid interest is added to the principal balance, creating negative amortization. Payments are later adjusted to a level that will fully amortize the loan's increased balance over the remaining loan term.
Pledged Account Mortgage
A pledged account mortgage (PAM) is a type of graduated payment mortgage under which the owner/borrower contributes a sum of money into an account that is pledged to the lender. The account is drawn on during the first three to five years of the loan to supplement the periodic mortgage payments, thereby reducing the borrower's monthly payments in the initial years. Once the account is empty, the borrower makes the full mortgage payment.
This is a variation of the PAM described above. In a buydown, the lump sum payment that is made to the lender at closing usually comes from a builder as an incentive to the buyer or from a family member trying to help out. That payment serves to reduce the interest rate on the loan for the first few years. The builder may then pass the costs of the buydown through to the buyer in the form of a higher purchase price. At the end of the prescribed period, the rate rises. The lender assumes the borrower's income will also have risen during these years and he or she will be able to make the increased payments
In an interest-only loan, periodic payments over the loan term apply only to interest owed, not to principal. At the end of the term, the full balance must be paid off in a lump-sum, "balloon" payment. Since these loans have no periodic principal payback, their monthly payments are smaller than amortizing loans for the same amount at the same rate of interest.
Purchase money mortgage
With a purchase money mortgage, the borrower gives a mortgage and note to the seller to finance some or all of the purchase price of the property. The seller in this case is said to "take back" a note, or to "carry paper," on the property. Purchase money mortgages may be either senior or junior liens. This is a way for the buyer to borrow from the seller in addition to the lender. The purchase money mortgage is created at the time of the purchase and delivered at the time the property is transferred as part of the sale transaction.
In a wraparound loan arrangement, a borrower who has an existing loan obtains another loan from a second lender without paying off the first loan. The second lender issues a new larger loan to the borrower at a higher interest rate. The new loan is a combination of the first loan and the second loan. The borrower makes the new higher payments to the second lender and then the second lender pays the first lender out of those funds. A wraparound enables the buyer to obtain financing with a minimum cash investment. It also potentially enables the seller to profit from any difference between a lower interest rate on the senior loan and a higher rate on the wraparound loan. A wraparound is possible only if the senior mortgagee and the original loan documents allow it.
Contract for deed
Under a contract for deed arrangement, the seller retains title and the buyer receives possession and equitable title while making payments under the terms of the contract. The seller conveys title when the contract has been fully performed.
The buyer agrees to give the seller a down payment and to make regular payments of principal and interest for some agreed-upon number of years. The buyer also agrees to pay real estate taxes and insurance premiums and to maintain the repairs and upkeep of the property.
Home equity loan
A home equity loan is an alternative to refinancing. It can be given as a fixed amount or as a line of credit for the homeowner to borrow against as the need arises. The ostensible purpose of this type of loan is to obtain funds for home improvement. Structurally, the home equity loan is a junior mortgage secured by the homeowner's equity. For some lenders, the maximum home equity loan amount is based on the difference between the property's appraised value and the maximum loan-to-value ratio the lender allows on the property, inclusive of all existing mortgage loans. Thus if a home is appraised at $100,000 and the lender's maximum LTV is 80%, the lender will lend a total of $80,000. If the owner's existing mortgage balance is $65,000, the owner would qualify for a $15,000 home equity loan.
A package loan finances the purchase of real estate and personal property. For example, a package loan might finance a furnished condominium, complete with all fixtures and décor, including furniture, draperies, carpeting, kitchen appliances, washer and dryer, freezers and other items as part of the purchase price for the residence.
A construction loan finances construction of improvements. This type of loan is paid out by the lender in installments linked to stages of the construction process. The loan is usually interest-only, and the borrower makes periodic payments based on the amount disbursed so far. As short-term, high-risk financing, the interest rates are usually higher than those for long-term financing. The borrower is expected to find permanent ("take out") financing elsewhere to pay off the temporary loan when construction is complete.
A bridge, swing, or gap loan is used to cover a gap in financing between short-term construction financing and long-term permanent financing. For instance, a developer may have difficulty finding a long-term lender to take out the construction lender. However, as the construction loan is expensive and must be paid off as soon as possible, the developer may find an interim lender who will pay off the construction loan but not agree to a long-term loan.
In a participation loan, the lender participates in the income and/or equity of the property, in return for giving the borrower more favorable loan terms than would otherwise be justified. For instance, the borrower makes smaller periodic payments than the interest rate and loan amount require, and the lender makes up the difference by receiving some of the property's income. This type of loan usually involves an income property.
Permanent (take-out) loan
A permanent loan is a long-term loan that "takes out" a construction or short-term lender. The long-term lender pays off the balance on the construction loan when the project is completed, leaving the borrower with a long-term loan under more favorable terms than the construction loan offered.
In a reverse annuity mortgage (RAM), a homeowner pledges the equity in the home as security for a loan which is paid out in regular monthly amounts over the term of the loan. The homeowner, in effect, is able to convert the equity to cash without losing ownership and possession, and the lender, in effect, is making payments to the borrower. This system allows older property owners to receive regular monthly payments from the equity in their paid-off property without having to sell. The borrower pays a fixed rate of interest and then repays the loan either when the home sells or from the borrower's estate upon his or her death.
This is an expandable loan which gives a borrower a limit up to which he or she may borrow. Each incremental advance must be secured by the same mortgage and any advances may not exceed the original borrowing limit.
Sale and Leaseback
This financing arrangement is typically used by commercial enterprises to free up money that has been tied up in the real estate to use as working capital in the business. The owner of the real estate sells the property and then leases it back from the buyer. The buyer becomes the owner (lender) and the former owner becomes the tenant (borrower). These arrangements are very complicated and should be undertaken only with proper and adequate legal and tax advice.
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