Loan Programs Fixed Rate Mortgages Adjustable Rate Mortgages (ARM) Standard ARMS and the Differences Introductory Rate ARM's Reverse Mortgages London Inter Bank Offered Rate (LIBOR) Balloon Mortgages Interest Rate Buydowns Cost of Funds Index (COFI) Graduated Payment Mortgage (GPM) FHA Loans

Fixed Rate Mortgages

The most common type of mortgage program where your monthly payments for interest and principal never change. Property taxes and homeowners insurance may increase, but generally your monthly payments will be very stable.

Fixed-rate mortgages are available for 30 years, 20 years, 15 years and even 10 years. There are also "bi-weekly" mortgages, which shorten the loan by calling for half the monthly payment every two weeks. (Since there are 52 weeks in a year, you make 26 payments, or 13 "months" worth, every year.)

Fixed rate fully amortizing loans have two distinct features. First, the interest rate remains fixed for the life of the loan. Secondly, the payments remain level for the life of the loan and are structured to repay the loan at the end of the loan term. The most common fixed rate loans are 15 year and 30 year mortgages.

During the early amortization period, a large percentage of the monthly payment is used for paying the interest . As the loan is paid down, more of the monthly payment is applied to principal . A typical 30 year fixed rate mortgage takes 22.5 years of level payments to pay half of the original loan amount.

Adjustable Rate Mortgages

These loans generally begin with an interest rate that is 2-3 percent below a comparable fixed rate mortgage, and could allow you to buy a more expensive home.

However, the interest rate changes at specified intervals (for example, every year) depending on changing market conditions; if interest rates go up, your monthly mortgage payment will go up, too. However, if rates go down, your mortgage payment will drop also.

There are also mortgages that combine aspects of fixed and adjustable rate mortgages - starting at a low fixed-rate for seven to ten years, for example, then adjusting to market conditions. Ask your mortgage professional about these and other special kinds of mortgages that fit your specific financial situation.

Standard ARM Programs

A few options are available to fit your individual needs and your risk tolerance with the various market instruments.

ARMs with different indexes are available for both purchases and refinances. Choosing an ARM with an index that reacts quickly lets you take full advantage of falling interest rates. An index that lags behind the market lets you take advantage of lower rates after market rates have started to adjust upward.

The interest rate and monthly payment can change based on adjustments to the index rate.

6-Month Certificate of Deposit (CD) ARM
Has a maximum interest rate adjustment of 1% every six months. The 6-month Certificate of Deposit (CD) index is generally considered to react quickly to changes in the market.

1-Year Treasury Spot ARM
Has a maximum interest rate adjustment of 2% every 12 months. The 1-Year Treasury Spot index generally reacts more slowly than the CD index, but more quickly than the Treasury Average index.

6-Month Treasury Average ARM
Has a maximum interest rate adjustment of 1% every six months. The Treasury Average index generally reacts more slowly in fluctuating markets so adjustments in the ARM interest rate will lag behind some other market indicators.

12-Month Treasury Average ARM
Has a maximum interest rate adjustment of 2% every 12 months. The treasury Average index generally reacts more slowly in fluctuating markets so adjustments in the ARM interest rate will lag behind some other market indicators.

Introductory Rate ARM's

Most adjustable rate loans (ARMs) have a low introductory rate or start rate, some times as much as 5.0% below the current market rate of a fixed loan. This start rate is usually good from 1 month to as long as 10 years. As a rule the lower the start rate the shorter the time before the loan makes its first adjustment.

Index - The index of an ARM is the financial instrument that the loan is "tied" to, or adjusted to. The most common indices, or, indexes are the 1-Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month Certificate of Deposit (CD) and the 11th District Cost of Funds (COFI). Each of these indices move up or down based on conditions of the financial markets.

Margin - The margin is one of the most important aspects of ARMs because it is added to the index to determine the interest rate that you pay. The margin added to the index is known as the fully indexed rate. As an example if the current index value is 5.50% and your loan has a margin of 2.5%, your fully indexed rate is 8.00%. Margins on loans range from 1.75% to 3.5% depending on the index and the amount financed in relation to the property value.

Interim Caps - All adjustable rate loans carry interim caps. Many ARMs have interest rate caps of six-months or a year. There are loans that have interest rate caps of three years. Interest rate caps are beneficial in rising interest rate markets, but can also keep your interest rate higher than the fully indexed rate if rates are falling rapidly.

Payment Caps - Some loans have payment caps instead of interest rate caps. These loans reduce payment shock in a rising interest rate market, but can also lead to deferred interest or "negative amortization". These loans generally cap your annual payment increases to 7.5% of the previous payment.

Lifetime Caps - Almost all ARMs have a maximum interest rate or lifetime interest rate cap. The lifetime cap varies from company to company and loan to loan. Loans with low lifetime caps usually have higher margins, and the reverse is also true. Those loans that carry low margins often have higher lifetime caps.

Reverse Mortgage

A reverse mortgage is a special type of loan made to older homeowners to enable them to convert the equity in their home to cash to finance living expenses, home improvements, in-home health care, or other needs.

With a reverse mortgage, the payment stream is "reversed." That is, payments are made by the lender to the borrower, rather than monthly repayments by the borrower to the lender, as occurs with a regular home purchase mortgage.

A reverse mortgage is a sophisticated financial planning tool that enables seniors to stay in their home -- or "age in place" -- and maintain or improve their standard of living without taking on a monthly mortgage payment. The process of obtaining a reverse mortgage involves a number of different steps.

The first, most widely available reverse mortgage in the United States was the federally-insured Home Equity Conversion Mortgage (HECM), which was authorized in 1987.

A reverse mortgage is different from a home equity loan or line of credit, which many banks and thrifts offer. With a home equity loan or line of credit, an applicant must meet certain income and credit requirements, begin monthly repayments immediately, and the home can have an existing first mortgage on it. In addition, there is no restriction on the age of borrowers.

In general, reverse mortgages are limited to borrowers 62 years or older who own their home free and clear of debt or nearly so, and the home is free of tax liens.

Borrowers usually have a choice of receiving the proceeds from a reverse mortgage in the form of a lump-sum payment, fixed monthly payments for life, or line of credit. Some types of reverse mortgages also allow fixed monthly payments for a finite time period, or a combination of monthly payments and line of credit. The interest rate charged on a reverse mortgage is usually an adjustable rate that changes monthly or yearly. However, the size of monthly payments received by the senior doesn't change.

Some reverse mortgage products also involve the purchase of an annuity that can assure continued monthly income to the senior homeowner even after they sell the home.

The size of reverse mortgage that a senior homeowner can receive depends on the type of reverse mortgage, the borrower's age and current interest rates, and the home's property value. The older the applicant is, the larger the monthly payments or line of credit. This is because of the use of projected life expectancies in determining the size of reverse mortgages.

Seniors do not have to meet income or credit requirements to qualify for a reverse mortgage.

Unlike a home purchase mortgage or home equity loan, a reverse mortgage doesn't require monthly repayments by the borrower to the lender. A reverse mortgage isn't repayable until the borrower no longer occupies the home as his or her principal residence.

This can occur if the sole remaining borrower dies, the borrower sells the home, or the borrower moves out of the home, say, to a nursing home.

The repayment obligation for a reverse mortgage is equal to the principal balance of the loan, plus accrued interest, plus any finance charges paid for through the mortgage. This repayment obligation, however, can't exceed the value of the home.

The loan may be repaid by the borrower or by the borrower's family or estate, with or without a sale of the home. If the home is sold and the sale proceeds exceed the repayment obligation, the excess funds go to the borrower or borrower's estate. If the sales proceeds are less than the amount owed, the shortfall is usually covered by insurance or some other party and is not the responsibility of the borrower or borrower's estate. In general, the repayment obligation of the borrower or borrower's estate can't exceed the value of the property.

In general, a borrower can't be forced to sell their home to repay a reverse mortgage as long as they occupy the home, even if the total of the monthly payments to the borrower exceeds the value of the home.

LIBOR

LIBOR, London InterBank Offered Rate, is the rate on dollar-denominated deposits, also know as Eurodollars, traded between banks in London. The index is quoted for one month, three months, six months as well as one-year periods.

LIBOR is the base interest rate paid on deposits between banks in the Eurodollar market. A Eurodollar is a dollar deposited in a bank in a country where the currency is not the dollar. The Eurodollar market has been around for over 40 years and is a major component of the International financial market. London is the center of the Euromarket in terms of volume.

The LIBOR rate quoted in the Wall Street Journal is an average of rate quotes from five major banks. Bank of America, Barclays, Bank of Tokyo, Deutsche Bank and Swiss Bank.

The most common quote for mortgages is the 6-month quote. LIBOR's cost of money is a widely monitored international interest rate indicator. LIBOR is currently being used by both Fannie Mae and Freddie Mac as an index on the loans they purchase.

LIBOR is quoted daily in the Wall Street Journal's Money Rates and compares most closely to the 1-Year Treasury Security index.

Balloon Mortgages

Balloon loans are short term mortgages that have some features of a fixed rate mortgage. The loans provide a level payment feature during the term of the loan, but as opposed to the 30 year fixed rate mortgage, balloon loans do not fully amortize over the original term. Balloon loans can have many types of maturities, but most balloons that are first mortgages have a term of 5 to 7 years.

At the end of the loan term there is still a remaining principal loan balance and the mortgage company generally requires that the loan be paid in full, which can be accomplished by refinancing. Many companies have other options such as a conversion feature at the end of the term. For example, the loan may convert to a 30 year fixed loan at the thirty year market rate plus 3/8 of a percentage point. Your conversion can be guaranteed based on certain criteria such as having made your last 24 payments on time. The balloon mortgage program with the conversion option is often called a 7/23 Convertible or 5/25 Convertible.

Buydown Options

The most common buydown is the 2-1 buydown. In the past, for a buyer to secure a 2-1 buydown they would pay 3 points above current market points in order to pay a below market interest rate during the first two years of the loan. At the end of the two years they would then pay the old market rate for the remaining term.

As an example, if the current market rate for a conforming fixed rate loan is 8.5% at a cost of 1.5 points, the buydown gives the borrower a first year rate of 6.50%, a second year rate of 7.50% and a third through 30th year rate of 8.50% and the cost would be 4.5 points. Buydown were usually paid for by a transferring company because of the high points associated with them.

In today's market, mortgage companies have designed variations of the old buydowns rather than charge higher points to the buyer in the beginning they increase the note rate to cover their yields in the later years.

As an example, if the current rate for a conforming fixed rate loan is 8.50% at a cost of 1.5 points, the buydown would give the buyer a first year rate of 7.25%, a second year rate of 8.25% and a third through 30th year rate of 9.25% , or a three-quarter point higher note rate than the current market and the cost would remain at 1.5 points.

Another common buydown is the 3-2-1 buydown which works much in the same ways as the 2-1 buydown, with the exception of the starting interest rate being 3% below the note rate. Another variation is the flex-fixed buydown programs that increase at six month interval rather than annual intervals.

As an example, for a flex-fixed jumbo buydown at a cost of 1.5 points, the first six months rate would be 7.50%, the second six months the rate would be 8.00%, the next six months rate would be 8.50%, the next six months rate would be 9.00%, the next six months the rate would be 9.50% and at the 37th month the rate would reach the note rate of 9.875% and would remain there for the remainder of the term. A comparable jumbo 30 year fixed at 1.5 points would be 8.875%.

COFI ARM Cost of Funds Index

The 11th District Cost of Funds is more prevalent in the West and the 1-Year Treasury Security is more prevalent in the East. Buyers prefer the slowly moving 11th District Cost of Funds and investors prefer the 1-Year Treasury Security.

The monthly weighted average Eleventh District has been published by the Federal Home Loan Bank of San Francisco since August 1981. Currently more than one half of the savings institutions loans made in California are tied to the 11th District Cost of Funds (COF) index.

The Federal Home Loan Bank's 11th District is comprised of saving institutions in Arizona, California and Nevada.

Few people who use and follow the 11th District Cost of Funds understand exactly how it is calculated, what it represents, how it moves and what factors affect it.

The predecessor to the 11th District Cost of Funds index was the District semiannual weighted average cost of funds published for a six month period ending in June and December. The San Francisco Bank was the first Federal Home Loan Bank to publish a monthly cost of funds index.

The funds used as a basis for the calculation of the 11th District Cost of Funds index are the liabilities at the District savings institutions: money on deposit at the institutions, money borrowed from a Federal Home Loan Bank (known as advances) and all other money borrowed. The interest paid on these types of funds is the cost of these funds.

The ratio of the dollar amount paid in interest during the month to the average dollar amount of the funds for that month constitutes the weighted average cost of funds ratio for that month.

The average cost of funds is said to be weighted because the three kinds of funds and their costs are added together before a ratio is computed rather than calculating averages individually for the three sources and using a simple average of the three ratios. This gives the greatest weight to the interest paid on deposits, and explains the delayed reaction of the index to rising fixed-rate mortgages

Graduated Payment Mortgage

The GPM is another alternative to the conventional adjustable rate mortgage, and is making a comeback as borrowers and mortgage companies seek alternatives to assist in qualify for home financing

Unlike an ARM, GPMs have a fixed note rate and payment schedule. With a GPM the payments are usually fixed for one year at a time. Each year for five years the payments graduate at 7.5% - 12.5% of the previous years payment.

GPMs are available in 30 year and 15 year amortization, and for both conforming and jumbo loans. With the graduated payments and a fixed note rate, GPMs have scheduled negative amortization of approximately 10% - 12% of the loan amount depending on the note rate. The higher the note rate the larger degree of negative amortization. This compares to the possible negative amortization of a monthly adjusting ARM of 10% of the loan amount. Both loans give the consumer the ability to pay the additional principal and avoid the negative amortization. In contrast, the GPM has a fixed payment schedule so the additional principal payments reduce the term of the loan. The ARMs additional payments avoid the negative amortization and the payments decrease while the term of the loan remains constant.

The scheduled negative amortization on a GPM differs depending on the amortization schedule, the note rate and the payment increases of the loan. GPM loans with 7.5% annual payment increases offer the lowest qualifying rate but the largest amount of negative amortization.

On a loan of $150,000, with a 30 year amortization and a note rate of 10.50% with 12.5% annual payment increases, the negative amortization continues for 60 months. The qualifying rate is 5.75% and the negative amortization is 11.34% (approximately $17,010).

The note rate of a GPM is traditionally .5% to .75% higher than the note rate of a straight fixed rate mortgage. The higher note rate and scheduled negative amortization of the GPM makes the cost of the mortgage more expensive to the borrower in the long run. In addition, the borrowers monthly payment can increase by as much as 50% by the final payment adjustment.

The lower qualifying rate of the GPM can help borrowers maximize their purchasing power, and can be useful in a market with rapid appreciation. In markets where appreciation is moderate, and a borrower needs to move during the scheduled negative amortization period they could create an unpleasant situation.

FHA Mortgage Loans

Down Payment Gifts

The down payment can be 100% gift funds. This is one of the key benefits to the FHA program.

Verification of the source of gift money is not required. However, it is necessary that the gift funds be deposited in the borrower's bank or savings account, or in an escrow account, prior to underwriting approval. Proof of deposit is required.

Gift donors are restricted primarily to a relative of the borrower. They can also be certain organizations, such as a labor union or charitable organization. Contact your local branch for complete information

Bankruptcy and Foreclosure

A credit report will be obtained on the borrower and any lates, collections, judgments, foreclosures, bankruptcies, etc. must have a justifiable explanation in writing by the borrower.

In the event of a foreclosure, the borrower has three years from the date the claim was paid until he/she is eligible for another FHA loan, unless the foreclosure was the result of extenuating circumstances beyond the borrower's control and the borrower has since established good credit.

Chapter 7 bankruptcy requires the borrower to wait at least two years from the date of discharge.

Chapter 13 bankruptcy requires the borrower to have been paying on the bankruptcy for at least one year, performance must have been satisfactory and the borrower must also receive court approval to enter into the mortgage transaction

FHA Mortgage Insurance

FHA requires a mortgage insurance premium (MIP) for its homebuying programs. An up-front premium of 1.50% of the loan amount is paid at closing and can be financed into the mortgage amount. In addition, there is a monthly MIP amount included in the PITI of .50%. Condos do not require up front MIP - only monthly MIP.

The mortgage insurance premium paid on an FHA loan is always significantly higher than on a conventional program. On an FHA loan the borrower will be charged a mortgage insurance premium equal to 1.50% of the purchase price of the property and a renewal premium of .500% in subsequent years. By contrast the mortgage insurance premium charged at closing on a conventional program is as low as .500% (with 10% down payment) with renewal rate in subsequent years as low as .300% in subsequent years

Refunds on FHA Loans

If you have ever paid off a home loan backed by FHA, you may have money owed to you. And the government wants to pay you back.

About 1 in 10 FHA borrowers leave money in their escrow accounts when they pay off their loans. The average refund for each borrower is about $700.

Former FHA borrowers who think they might be due a refund can call a toll free number, 800-697-6967, or write HUD at P.O. Box 23669, Washington DC 20026-3699.

Streamline Refinancing for FHA Mortgages

FHA has permitted streamline refinances on insured mortgages since the early 1980's. The streamline refers only to the amount of documentation and underwriting that needs to be performed by the mortgage company, and does not mean that there are no costs involved in the transaction.

The basic requirements of a streamline refinance are:

• The mortgage to be refinanced must already be FHA insured.

• The mortgage to be refinanced should be current (not delinquent).

• The refinance is to result in a lowering of the borrower's monthly principal and interest payments.

• No cash may be taken out on mortgages refinanced using the streamline refinance process.

Companies may offer streamline refinances in several ways. Some companies offer "no cost" refinances (actually, no out-of-pocket expenses to the borrower) by charging a higher rate of interest on the new loan than if the borrower financed or paid the closing costs in cash. From this premium, the company pays any closing costs that are incurred on the transaction.

Companies may offer streamline refinances and include the closing costs into the new mortgage amount. This can only be done if there is sufficient equity in the property, as determined by an appraisal. Streamline refinances can also be done without appraisals, but the new loan amount cannot exceed what is currently owed, i.e., closing costs may not be added to the new mortgage with those costs either paid in cash or through the premium rate as described above. Investment properties (properties in which the borrower does not reside in as his or her principal residence) may only be refinanced without an appraisal and, thus, closing costs may not be included in the new mortgage amount.

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