Balloon Payment Mortgages
A balloon payment mortgage is home loan that does not fully amortize over the term of the loan. The payment on a balloon mortgage loan is calculated over a predetermined period, most commonly for 30 years, but the balance of the loan is due or payable after a specified period before the 30 years. An example of this is a five year balloon home loan. This home loan would have principal and interest payments based on a 30 year loan, but the outstanding balance has to be repaid in full before the end of the five year term. This payment is at the end of the term is how the balloon name was derived.
The most popular balloon mortgages have a fixed rate period of either five or seven years with a thirty-year amortization and generally they will not have a prepayment penalty. At the end of 7 or 5 years the borrower has usually two options to make the final balloon payment. The home can be sold to pay off the home loan or the borrower can refinance the home loan. Either option can be exercised up to the time the term of the home loan ends.
There is another type of balloon option to handle the remaining balance at the end of the term. This option is found in some balloon payment mortgages and has an option to extend the home loan for the remaining term at the prevailing market rates adjusted according to terms in the original mortgage note. The rate then remains fixed for the rest of the home loan term. This feature is referred to a convertible option, since you may convert the mortgage loan to a fixed rate at that time. The home loan may also be referred to as a two-step, the first step is the balloon term and the second step is the conversion. The general conditions to be able to convert include; the home is still your primary residence, you have a good payment history and your payment is current and there are no additional liens on the property.
The interest rates on balloon payment mortgages are generally lower than that of a 30 year fixed rate mortgage loans. The major advantages of the balloon payment mortgage are; lower interest rates, lower payments and the ability to qualify to buy a larger home. Generally these mortgage loans are considered when the borrower does not expect to be in the home at the end of the fixed mortgage loan term. Of course there are some disadvantages to the balloon mortgage, most notably, continually worrying about the end of the fixed rate period when the large balloon mortgage payment will be due.
The balloon payment mortgage is clearly not for everyone to consider. When interest rates and mortgage rates are low from the short term to the long term, the slight benefit of a balloon with a lower mortgage rate is eroded. Most home buyers however, do not have the same mortgage five or seven years later, they have since moved and paid off or did a mortgage refinance. Weighing the benefits and risks of the features on these mortgage loans against your needs will determine if the mortgage rate and costs of this product should be considered further.
Always investigate the differences in mortgage rates between the balloon mortgage loan and a standard fully amortizing home loan. These homes can be used for both a home purchase as well as a mortgage refinance. Use a mortgage calculator to help compare the mortgage rates, mortgage payments and the amortization schedule on the loan including the balloon payment can be very useful to determine if this type of home loan is right for you.
Top Five Mistakes When Refinancing
There are many reasons borrowers make mistakes when they refinance their homes. Poor decisions in a refinance can be a costly error, it can mean paying fees, incurring unwanted debt and excessive interest when a less expensive home loan alternative was available. In light of how much information is available on mortgage programs, the availability of mortgage calculators for payment assistance and self help resources it’s startling the number of unfortunate judgments that are executed regarding someone’s home and mortgage loan. The wrong mortgage rate is not the number one mistake in home loan refinancing.
1.) The number one mistake is not understanding all of the terms of the new mortgage loan. Most consumers stuck with adjustable rate loans with high interest rates rushed into the home loan and failed to understand the mortgage terms. Make sure you fully understand the cost, mortgage rate, length of the loan and any penalties for early payment. Understand the terms of the new home loan and do the math on what the new payments will be, the loan amount and how long it will be to pay it off.
2.) The second most common error is to choose a refinance for the wrong reasons. If you are getting a refinance for cash back understand why you are taking out the cash. If you extract equity in your home for normal consumption perhaps the problem is your own personal budget. A refinance generally involves a longer term or greater loan amount then you presently have. If the funds of this refinance are not used prudently you are only going further into debt without much benefit. Perhaps it is possible to repair your credit situation and budget without the mortgage refinance.
3.) Not shopping smart is the number three problem. If a potential mortgage loan applicant obtains the bulk of their information in writing, this problem can often be ameliorated. Comparing the good faith estimates of the mortgage lender is a good starting point. Compare truth in lending notices. Talk to more than one source for your home loan request. Though this mistake sounds repetitive, the issue here is, a borrower taking a refinance that may very well be a good mortgage loan product but the borrower is saddled with a higher than market mortgage rate and high costs by not thoroughly shopping.
4.) Not considering the other options available. The most frequent problem here is getting cash back for short term needs. Though this may be a necessity consider other options such as budgeting, personal loans, or a home equity loan.
5.) Lastly, getting a refinance to solve a budget problem not a mortgage problem. Seeking a reduced mortgage loan payment without understanding you may be taking a negative amortization adjustable rate mortgage is simply postponing some financial housekeeping. Mortgage debt is harder to repay, don’t solve lifestyle problem by placing more debt on your home.
Always, research the terms, benefits, and costs of any mortgage transaction. Never rush into a home loan. If you are not completely happy with your choices or the information you are getting; breathe, wait and start the research process all over again. A mortgage company is in the service business. Make them serve you. Shop smart and revive the best mortgage rates and terms to fit your needs.
Risky Home Mortgages
Mortgages with risky terms or ones based on dicey credit standards are mortgages that can cause you problems. High risks mortgages may have an appropriate use in the mortgage marketplace for those borrowers who do not meet conforming guidelines. Borrowers who exhibit the needs of a high risk loan commonly needed a mortgage loan due to slow credit, extremely high loan amounts relative the homes value, or loans to speculate on real estate. In an earlier period, high risk loans were introduced to serve just this market segment. High risk loans were designed to relax the requirements for credit standards, little to no down payments and excessive debt ratios. Sub prime loans are the typical loan type we think of regarding high risk lending. As of recent, these loans have morphed and have now been used for a variety of purposes and sold to borrowers who don’t fall into a category of needing a home loan used for high risk transactions.
A mortgage is a loan that provides you with the resources to buy a home. If you aren’t educated about the types of loans that are available, some lenders may attempt to sell you a mortgage with lots of features and variations that don’t apply to your particular needs. There are many different products out there and some of them are dangerous. Make sure you know about high risk mortgages that can potentially get you in trouble. With slightly higher rates or conditions that are pushed onto the borrower, many lenders find offering these products more attractive for their overall rate of return.
Option ARM (adjustable rate mortgage) loans are probably the most dangerous type of mortgage. These loans give you a lot of flexibility when your monthly payment is due: pay a little or pay a lot. However, you can get in trouble very easily. Option ARM loans are mortgages that give a borrower a choice on how much a given payment is. This seems like a valuable feature inasmuch as you have the flexibility to respond to month to month circumstances. You can make a minimum payment, a full payment, or an interest only payment. These loans are filled with pitfalls.
First, you don’t build equity unless you make the full payments that you would make with a conventional mortgage. Given a choice between a large payment and a small payment, which one will you choose? With the smaller payments, you’ll actually owe more on your house at the end of the month than you did at the beginning, a situation of negative amortization.
Another peril of an Option ARM is that small payments will not last forever. Sooner or later the bank will want to put you back on schedule to pay the loan off, and will “recast” your loan at given intervals, or when you owe too much on the home (110% or 120%, for example) due to negative amortization. When they recast, they set the loan on track to fully amortize over its remaining life, and your minimum payment can increase sharply. If your budget can’t afford this increase, you’re in trouble.
An option ARM is almost always a bad idea. The mortgage rates on option ARM’s are initially a very low teaser mortgage rate. As soon as the introductory rate period or teaser rate is over the fully adjusted rate on this loan is as high as a 30 year fixed rate loan. Sometimes, the fully adjusted rate is distinctly higher than a 30 year fixed rate. If the introductory rate lasted a reasonable length of time, the low initial rate may have some value. The problem with the option ARM is that this teaser rate expires anywhere from one month to six months. The option ARM is clearly one of the worst loan products that were sold on a wide scale and in the category of Arms has the least favorable terms.
Interest only loans give you the ability to pay less each month because you’re not repaying principal. You can set up your own amortization schedule, that is, a schedule for paying back principal. However, you can also end up without any equity in your home – and possibly have to write a check if your home loses value and you want to sell it. Interest only loans should be used by the most disciplined of borrowers. The interest only option allows for a lower payment but, the principal has to be paid back at sometime. Delaying the repayment based on estimates of future home appreciation or the ability to refinance at a later date under more favorable terms may be a gamble that can cost you your home.
The home loan programs that have yielded some of the biggest problems this year are the no income verification loans and the various permutations of them. Alt-A, no income, no doc, and stated income are all terms to describe similar loan programs. These loan types don’t require the borrower to document their income. For the self-employed borrower who would employ aggressive techniques for write offs against their revenue stream or income, these loans filled a need. Recently, the use of low document income loans or no document income loans were used for wage earners and borrowers who had income that would have been easily verified. These mortgage loans may allow a borrower to qualify for a loan that under normal underwriting guidelines would have been impossible. The risk and cost for the borrower is now trying to figure out how to make the monthly payment on a loan based on income that they did not actually earn. Foreclosure figures on this loan type are certainly proving that not verifying income is not a free ride to homeownership.
Many of these loans have in fact opened the door for increased number of borrowers to become homeowners. Some of these home loan products may be appropriate for you. If you’re thinking of using one of these loans make sure you understand the risks. Don’t be tempted by the reassurances of a mortgage lender that profits at your risk. It may make more sense to buy a less expensive house with a fixed rate mortgage or repair your damaged credit first. Do your research and comparison shop before making the leap.
Facts about Adjustable Rate Mortgages
An adjustable rate mortgage, called an ARM for short, is a mortgage with an interest rate that is tied to a financial index rate set by the marketplace, and your payment will move up and down as interest rates adjusts rates up or down. The interest rate and your payments are periodically adjusted up or down as the index changes. It’s obvious that if rates go down, that’s good for you. In addition, you often get a lower starting rate because you’re sharing interest rate risk with the lender. However, if rates rise, that’s not good. There is an element of risk in adjustable rate mortgages.
An index is an interest rate that lenders use to determine interest rate changes on your mortgage loan. As the indexed rate moves up or down, so does the rate on your loan. Common indexes used by lenders include rates for short or mid term Treasury securities, but there are other indexes such as the cost of funds index, the LIBOR rate, and the prime rate. The index your mortgage uses is a technicality to determine the fully indexed mortgage rate, but it can affect how your payments change.
The margin on the loan is the lender’s markup. It is an interest rate that represents the lender’s cost of doing business plus the profit they will make on the loan. The margin is added to the index rate to determine your total interest rate. The margin will always stay the same during the life of a loan even if the overall rate adjusts down or up. It is the index that adjusts, not the margin. When comparing mortgage lenders, you must consider both the index and the margin rate being offered.
The adjustment period is the period between potential interest rate adjustments. You may see an ARM described with adjustment periods yearly. In this case loan during the first year your interest rate will stay the same as it was on the day you signed your loan papers. After that period the interest rate will adjust to the index rate at that time plus the margin. This number is the fully indexed rate and will be the basis for the mortgage payment until the next adjustment cycle. This example was as ARM with an annual adjustment–meaning adjustments could happen every year. Some ARMs adjust more frequently, or adjust sooner, or later.
Some adjustable rate loans have features that protect you against sudden or large shifts in rates. They do this by placing a cap on the total number of percentage points that the rate can rise. Caps are broken down into adjustment period caps and annual caps. The adjustment period cap limits the amount the rate can rise above the starting rate by a predetermined limit at the anniversary of the adjustment period. The lifetime interest rate cap will place a ceiling on the highest rate change the interest rate can be over the life of the home loan.
If payments can go up, why should you consider an ARM? You might qualify for a larger loan with an ARM. The initial interest rate for an ARM is lower than that of a fixed rate mortgage, where the interest rate remains the same during the life of the loan. A lower rate means lower payments, which might help you qualify for a larger mortgage loan. Also, you may not plan to remain in your house more than a few years. If you like to move frequently or must move frequently because of your job, you may benefit from the initial lower rate of an adjustable rate loan. The possibility of mortgage rate increases isn’t much of a factor if you plan to sell the home within a few years.
You also may have a reasonable expectation of increases in your personal income. Or, you may anticipate adding an income to your home through marriage, or a younger or older relative with an income. You don’t want to bet on increases in household income, but you can consider it if you really believe it will happen.
Some ARMs have a convertible feature that allows the loan to be converted to a fixed-rate mortgage. However, they have conversion requirements and the mortgage rate to which the loan will convert is dependent on the market at that time which may take away the savings you realized with the initial lower mortgage rate.
Payment caps are confusing feature found in a select category of ARMs. Payment caps limit how much your monthly mortgage payment can change during an adjustment period. The confusion many customers have experienced is that the payment cap does not stop the interest rate from changing. In a situation in which the rate goes above the amount used for the payment cap, negative amortization will begin. Negative amortization occurs when an ARM has a payment cap that keeps monthly payments from covering the cost of interest. The unpaid amount is added back to the home loan, where it generates even more interest debt. If this continues you could make many payments, but still owe more than you did at the beginning of the home loan. Negative amortization is one of the really bad things that can happen with ARMs in rare circumstances. This is a situation to avoid if possible, unless you fully understand the risk s involved.
If you consider an adjustable rate mortgage, know how changes in the interest rate will change your payment. It’s one thing to acknowledge that the payment will go up, but it’s entirely another thing to see what the actual payment will be, especially if it falls outside of your budget. As always, don’t hesitate to ask as many questions as it takes to help you understand every aspect of ARMs and other home loans that are offered to you. Mortgage lenders are required to give you written information to help you compare and select a mortgage loan, but additional discussion is almost always required.