Chapter 3: Types of Mortgages

What were the primary mortgage choices twenty years ago?

A 30-year fixed rate, a 15-year fixed rate, and an adjustable rate mortgage.

Name the three major groups into which mortgages are categorized in this chapter.

• Fixed rate and fixed payment mortgages.

• Fixed rate hybrids: non-fixed payments and balloons.

• Adjustable rate mortgages.

What is a fixed rate mortgage?

Simplest option where the interest rate and payments remain the same over the loan term.

What is the "term" of a mortgage?

The life of a mortgage; the period of time over which the money is lent.

What does "fully amortized" mean for a mortgage?

A mortgage that is paid off completely by the end of its term. Decrease the principal balance on the mortgage on a monthly basis.

Why is a 30-year fixed rate mortgage generally more popular than 15-year or 20-year options?

It requires the lowest monthly payment, which maximizes the tax deduction as more of the payment goes to interest.

What is the key financial advantage of a 15-year fixed rate mortgage over a 30-year?

Faster payoff of the principal and significant interest savings over the mortgage term, despite a higher monthly payment.

How do interest rates for 15-year mortgages typically compare to 30-year mortgages?

generally at a rate approximately 0.25% below

What is a "prepayment penalty"?

A sum of money that must be paid if the mortgage is paid off before the term is up or paid down faster than the amortization schedule requires.

How does a "bi-weekly mortgage" work, and what is its main effect?

It involves making one-half of the monthly mortgage payment every two weeks. This results in effectively making one extra monthly mortgage payment each year, leading to a payoff in approximately 23 years

What is a disadvantage of a bi-weekly mortgage related to the secondary market?

No lower interest rate in the short term, as well as less flexibility with payments.

What is an interest only program?

Offers lower monthly payments as only interest is paid for a period.

What is a fixed rate hybrid?

Mortgages that either don't have fixed payments or aren't fully amortized.

Under fixed rate hybrids, what is a "balloon mortgage"?

A fixed rate and fixed payment mortgage that does not amortize completely, requiring a lump sum payment of all remaining principal at the end of a specified interval.

Provide an example of how a balloon mortgage term is expressed.

"30 due in 5" & "30/5". mortgage amortizes payments over 30 years but has a balloon payment at the end of the fifth year.

What is one risk associated with balloon mortgages?

The borrower is "gambling" on either moving or refinancing before the short term is complete, and factors like a recession or job loss could prevent this.

What is a "conditional right to refinance option" on a balloon mortgage?

Offered by Freddie Mac and Fannie Mae, it allows the applicant to refinance the mortgage to a fixed rate for the remaining term after the balloon occurs, under certain conditions.

Under fixed rate hybrids, what is Graduated Payment Mortgages (GPMs)?

Fixed interest rate, but payments vary over the term in a predetermined way.

Biggest reason a GPM is different than an ARM?

payment variations are known at the inception of the mortgage term, they are predetermined.

What is a "Growing Equity Mortgage" (GEM)?

A type of GPM where the rate of mortgage payoff increases with each increase in payment, allowing the loan to be paid off faster than its initial amortization schedule.

What is the core "theory" behind Growing Equity Mortgages (GEMs)?

The "delay of pain" theory, allowing borrowers to start with lower payments (like a 30-year fixed) and gradually increase to higher payments (like a 15-year fixed) over time as their income is expected to grow.

What is the purpose of a "temporary buydown mortgage"?

lower the interest rate during a certain period (usually the first few years) of the mortgage's term to make payments more affordable initially, allowing the borrower's income to grow into higher payments later.

For a temporary buydown, what is the "note rate"?

It's the base interest rate from which the buydown lowers the effective rate for a specific period. (pre buydown)

What is an "odd buydown" and what is the key rule governing it?

A buydown where the note rate is bought down by less than a full percentage point each year. The basic rule is that each year the rate of the mortgage cannot increase more than 1.0%.

What is a "lender-subsidized buydown"?

A mortgage where the total cost in terms of points is less than the cost of the buydown itself, meaning the lender is supplying some of the points necessary for the buydown funds.

What is an Adjustable rate mortgage (ARM)?

Loan with Interest rates change over time based on an index and a margin.

What is an "index" in the context of an Adjustable Rate Mortgage (ARM)?

indicator or reference of particular interest rates that determines the rate of the mortgage in future years.

What is an "margin" in the context of an Adjustable Rate Mortgage (ARM)?

A profit margin added to the index to determine the new rate.

3 types of Treasury Constant Maturity Indices (TCM) based on term

• "T" Bills (short-term, e.g., 3-month).

• "T" Notes (medium-term, e.g., 3-year).

• "T" Bonds (long-term, e.g., 30-year).

What is the 11th District Cost of Funds Index (COFI), and where did it originate?

measure of the expense savings and loan institutions. Originated in California in the 80s.

What is the LIBOR Index?

Short for London Interbank Offered Rates, it's the average rate of interest that major international banks are willing to pay each other in the London Interbank Market for US dollar-denominated deposits for various terms.

What is a "teaser rate" on an ARM?

A starting rate for an ARM that is below the market rate or the Fully Indexed Accrual Rate (FIAR), offered to make the mortgage initially more attractive to consumers.

what is the FIAR equation?

= index + margin

What are "hybrid ARMs"?

Starts with a fixed interest rate for a set period, then the interest rate adjusts periodically based on market conditions for the remaining loan term.

What is an "adjustment period cap" on an ARM? What is the most common cap percentage?

A limit on how much the interest rate can change during each adjustment period (e.g., annually for a 1-year ARM). The most common cap is 2.0%

What is a "life cap" on an ARM?

The max the interest rate can reach in entire term of the mortgage.

What is the "floor" of an Adjustable Rate Mortgage?

The lowest rate that an adjustable rate mortgage can achieve, often the initial starting or teaser rate.

In the "worst-case scenario" for an ARM, what factors primarily determine how fast the rate increases?

Where the ARM increases as fast as the caps allow, unaffected by the margin or index, common in early years due to teaser rates.

What is "potential negative amortization" in an ARM?

Monthly payments are set low enough that they don't cover the full interest due, causing the unpaid interest to be added to the principal balance.

What are "conversion features" on ARM?

The ability to convert the mortgage from an ARM to a fixed rate at some point during the loan term.

What is the formal name for FHA reverse mortgages?

The Home Equity Conversion Mortgage, or HECM.

What is the home equity conversion mortgage (HECM)?

Lend based on a homeowner's equity, with no monthly payments required until the home is sold, the borrower is deceased, or permanently moves.

What is unique about reverse mortgages regarding monthly payments?

The homeowner does not make monthly payments on the loan until the home is sold, the borrower becomes deceased, or permanently moves away.

Name three ways homeowners can receive money from a reverse mortgage.

• As a lump sum of cash.

• As an open line of credit.

• As a monthly income.

What is one eligibility requirement for Fannie Mae's Home Keeper reverse mortgage program?

One must be at least 62 years of age.