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Can someone explain briefly the different types of mortgages: ARMS, interest only, 80/20, etc. Which one would you choose for a 3-4 yr residency program in the southeast? Thanks.
Mortgage types
- Thread starter toogood1
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There are now a jillion different types of mortgages, so I obviously can't explain them all, but I'll explain the ones you asked about.
First off, the "standard" mortgage is and has been a 30-year fixed moretgage. The interest rate is fixed when you borrow the money, and stays fixed for the 30-year repayment period. A common variation on the 30-year fixed is the 15-year fixed, which has a 15-year repayment period (and interest rates are usually slightly lower for 15-year vs. 30-year loans.)
Adjustable rate mortgages allow the rate to adjust with market conditions. However, you are usually guaranteed a period of time for which the interest rate is fixed. For a 5/1 ARM, the rate is fixed for 5 years, and then is subject to adjustment. Often the rate can adjust higher than the prevailing rates for new 30-year fixed loans at the same time. The "1" specifies that the maximum adjustment frequency is once per year (i.e. the rate adjusts once per year after the first 5 years.) The introductory fixed interest rate on a 5/1 ARM is generally substantially lower than that of a 30-year fixed loan, making that loan attractive if you KNOW that you will not live in the house for longer than 5 years. There are also 7/1, 10/1, and probably other ARMs.
OK, about the 80/20: The "traditional" down payment for a house has been 20%. Although smaller down payments are now common, most lenders will require you to purchase PMI (Private Mortgage Insurance) if you put down less than 20% of the purchase price of the house. PMI is wasted money since it is not tax deductible (with the exception of for houses THIS year because of an 11th hour lame duck Republican Congress law) like interest is. So, the "bridge loan" was invented. A loan package consisting of not one but two mortgages is put together, and that's what the 80/10 (usually specified as 80/10/10) represents: The amount (percentage) of the first mortgage, the second mortgage, and the down payment. For an 80/10/10 loan, 10% is put down, the first mortgage is 80% and the second mortgage is 10%. Note that the first mortgage must never be more than 80% to avoid paying PMI. Another popular loan is an 80/15/5 loan. This is all intependent of the type of loan (fixed, ARM, etc) so the loans that comprise the package can usually be of any type. The second mortgage, however, generally has shorter terms, and a slightly higher interest rate. Because the mortgage interest of the second loan is tax-deductible, you generally come out ahead, for a fixed down payment amount (less than 20%) by using a bridge loan instead of paying PMI. Like I said, because of recent changes in tax laws, this may not be the case for houses purchased THIS (and maybe next -- I forget) year, since PMI will be tax-deductible for the duration of the loan.
If you are sure that you will be moving after your 3-4 year residency program, I would definitely go with a 5/1 ARM. Even if you weren't 100% sure, I would probably risk it, because if you find out along the way that you will for sure be staying, you could always do the math to see if you should refinance. But that's just me. Lots of people like the security of the fixed rate, but you can save a buttload of money with the lower interest rate of the ARM if you are willing to gamble a little.
First off, the "standard" mortgage is and has been a 30-year fixed moretgage. The interest rate is fixed when you borrow the money, and stays fixed for the 30-year repayment period. A common variation on the 30-year fixed is the 15-year fixed, which has a 15-year repayment period (and interest rates are usually slightly lower for 15-year vs. 30-year loans.)
Adjustable rate mortgages allow the rate to adjust with market conditions. However, you are usually guaranteed a period of time for which the interest rate is fixed. For a 5/1 ARM, the rate is fixed for 5 years, and then is subject to adjustment. Often the rate can adjust higher than the prevailing rates for new 30-year fixed loans at the same time. The "1" specifies that the maximum adjustment frequency is once per year (i.e. the rate adjusts once per year after the first 5 years.) The introductory fixed interest rate on a 5/1 ARM is generally substantially lower than that of a 30-year fixed loan, making that loan attractive if you KNOW that you will not live in the house for longer than 5 years. There are also 7/1, 10/1, and probably other ARMs.
OK, about the 80/20: The "traditional" down payment for a house has been 20%. Although smaller down payments are now common, most lenders will require you to purchase PMI (Private Mortgage Insurance) if you put down less than 20% of the purchase price of the house. PMI is wasted money since it is not tax deductible (with the exception of for houses THIS year because of an 11th hour lame duck Republican Congress law) like interest is. So, the "bridge loan" was invented. A loan package consisting of not one but two mortgages is put together, and that's what the 80/10 (usually specified as 80/10/10) represents: The amount (percentage) of the first mortgage, the second mortgage, and the down payment. For an 80/10/10 loan, 10% is put down, the first mortgage is 80% and the second mortgage is 10%. Note that the first mortgage must never be more than 80% to avoid paying PMI. Another popular loan is an 80/15/5 loan. This is all intependent of the type of loan (fixed, ARM, etc) so the loans that comprise the package can usually be of any type. The second mortgage, however, generally has shorter terms, and a slightly higher interest rate. Because the mortgage interest of the second loan is tax-deductible, you generally come out ahead, for a fixed down payment amount (less than 20%) by using a bridge loan instead of paying PMI. Like I said, because of recent changes in tax laws, this may not be the case for houses purchased THIS (and maybe next -- I forget) year, since PMI will be tax-deductible for the duration of the loan.
If you are sure that you will be moving after your 3-4 year residency program, I would definitely go with a 5/1 ARM. Even if you weren't 100% sure, I would probably risk it, because if you find out along the way that you will for sure be staying, you could always do the math to see if you should refinance. But that's just me. Lots of people like the security of the fixed rate, but you can save a buttload of money with the lower interest rate of the ARM if you are willing to gamble a little.
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Jota's summary is an extremely good one. I would add that the 80/10/10, 80/20, and 80/15/5 are commonly called "piggyback", "combination" or "combo" loans. A bridge loan is where you borrow from equity in your existing home to purchase a new one.
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For your reading pleasure ...
http://www.mtgprofessor.com/Tutorials2/Interest_Only.htm
http://www.mtgprofessor.com/A%20- Interest Only/misperceptions_about_interest-only_loans.htm
http://moneycentral.msn.com/content/Banking/Homefinancing/P118084.asp
http://www.bankrate.com/brm/news/mtg/20020620b.asp
They sum it up better than I ever could!
http://www.mtgprofessor.com/Tutorials2/Interest_Only.htm
http://www.mtgprofessor.com/A%20- Interest Only/misperceptions_about_interest-only_loans.htm
http://moneycentral.msn.com/content/Banking/Homefinancing/P118084.asp
http://www.bankrate.com/brm/news/mtg/20020620b.asp
They sum it up better than I ever could!
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Interest only is fine, as long as you are paying the full interest.
The problem occurred with the minimum payment, or "Option Loans". Washington Mutual was doing these for years. It gives 4 options: 1) pay the absolute minimum, at a teaser rate. So 200K at 5% = $833/month. But the teaser rate may allow you to pay $500 per month. This is called "Negative Amortization". The bankers/brokers sell it to you as a "deferred interest" that you can pay down later when you make more money.
THese were great loans for those buying homes in their last years of residency, where the income would jump from $30k per yr to $200k per yr.
I do NOT advise these loans.
Interest only where you pay just the fully calculated interest is great for a home that you will be out of in 3 yrs. However, there is a problem in our country with this:
Unless you are putting 10% down, less banks are allowing interest only on the 0 down, or 80-20 loans. That's where the problems are occuring.
I am on a 3/1 interest only for my Ann Arbor home. Chicago is a 5/1 fully amortized. In the past, I was on an Option arm for Miami condo - and it was an investment, so I could adjust based on rent, etc.
I advise Interest only for 3-5 yr if you are short term in house, and have 10% down. Otherwise, the market is leaning towards 30yr fixed. You can get that with a intro interest only as well.
The only other item I am strongly opposed to is the 15yr fixed. Unless you are independantly wealthy, retirment ready, or rent exceeds mortgage, tax, insurance, you should never be on 15yr money.
Thanks
The problem occurred with the minimum payment, or "Option Loans". Washington Mutual was doing these for years. It gives 4 options: 1) pay the absolute minimum, at a teaser rate. So 200K at 5% = $833/month. But the teaser rate may allow you to pay $500 per month. This is called "Negative Amortization". The bankers/brokers sell it to you as a "deferred interest" that you can pay down later when you make more money.
THese were great loans for those buying homes in their last years of residency, where the income would jump from $30k per yr to $200k per yr.
I do NOT advise these loans.
Interest only where you pay just the fully calculated interest is great for a home that you will be out of in 3 yrs. However, there is a problem in our country with this:
Unless you are putting 10% down, less banks are allowing interest only on the 0 down, or 80-20 loans. That's where the problems are occuring.
I am on a 3/1 interest only for my Ann Arbor home. Chicago is a 5/1 fully amortized. In the past, I was on an Option arm for Miami condo - and it was an investment, so I could adjust based on rent, etc.
I advise Interest only for 3-5 yr if you are short term in house, and have 10% down. Otherwise, the market is leaning towards 30yr fixed. You can get that with a intro interest only as well.
The only other item I am strongly opposed to is the 15yr fixed. Unless you are independantly wealthy, retirment ready, or rent exceeds mortgage, tax, insurance, you should never be on 15yr money.
Thanks
