B/C Loans
Loans that do not meet the borrower credit requirements of Fannie Mae and Freddie Mac are called 'B', 'C' and 'D' paper loans vs. 'A' paper conforming loans. B/C loans are offered to borrowers that may have recently filed for bankruptcy, foreclosure, or have had late payments on their credit reports. Their purpose is to offer temporary financing to these applicants until they can qualify for conforming "A" financing. The interest rates and programs vary, based upon many factors of the borrower's financial situation and credit history.

Fixed Rate Mortgages

With fixed rate mortgage (FRM) loan the interest rate and your mortgage monthly payments remain fixed for the period of the loan. Fixed-rate mortgages are available for 30, 25, 20, 15 years and 10 years. Generally, the shorter the term of a loan, the lower the interest rate you could get.

The most popular mortgage terms are 30 and 15 years. With the traditional 30-year fixed rate mortgage your monthly payments are lower than they would be on a shorter term loan. But if you can afford higher monthly payments a 15-year fixed-rate mortgage allows you to repay your loan twice as faster and save more than half the total interest costs of a 30-year loan.

The payments on fixed rate fully amortizing loans are calculated so that at the end of the term the mortgage loan is paid in full. 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.

With bi-weekly mortgage plan you pay half of the monthly mortgage payment every 2 weeks. It allows you to repay a loan much faster. For example, a 30 year loan can be paid off within 18 to 19 years.

Balloon loans are short-term fixed rate loans that have fixed monthly payments based usually upon a 30-year fully amortizing schedule and a lump sum payment at the end of its term. Usually they have terms of 3, 5, and 7 years.

The advantage of this type of loan is that the interest rate on balloon loans is generally lower than 30- and 15- year mortgages resulting in lower monthly payments. The disadvantage is that at the end of the term you will have to come up with a lump sum to pay off your lender, either through a refinance or from your own savings.

Balloon loans with refinancing option allow borrowers to convert the mortgage at the end of the balloon period to a fixed rate loan -- based upon the outstanding principal balance -- if certain conditions are met. If you refinance the loan at maturity you need not be requalified, nor the property reapproved. The interest rate on the new loan is a current rate at the time of conversion. There might be a minimal processing fee to obtain the new loan. The most popular terms are 5/25 Balloon, and 7/23 Balloon.

Adjustable Rate Mortgages

Variable or adjustable loan is loan whose interest rate, and accordingly monthly payments, fluctuate over the period of the loan. With this type of mortgage, periodic adjustments based on changes in a defined index are made to the interest rate. The index for your particular loan is established at the time of application.

The margin is fixed percentage points added to the index to compute the interest rate. The result will then be rounded to the nearest one-eighth of a percent.

Example:

The index is 5.3% and the margin is 2.5%,
then the new interest rate = 5.3% + 2.5% = 7.8%.
The nearest to 0.8% is 0.75% = 6/8%.
The result will be 7.75%.

The margins remain fixed for the term of the loan and are not impacted by the financial markets and movement of interest rates. Lenders use a variety of margins depending upon the loan program and adjustment periods.

Most ARMs have an interest rate caps to protect you from enormous increases in monthly payments. A lifetime cap limits the interest rate increase over the life of the loan. A periodic or adjustment cap limits how much your interest rate can rise at one time.

Examples:

1. The initial interest rate is 4.5%, the index is 7%, and the margin is 3%,
then the new interest rate = 7% + 3% = 10%.
If the lifetime cap is 5% then
the actual new interest rate will be 4.5% + 5% = 9.5%.

2. The initial interest rate is 6%, the index is 5%, and the margin is 3%,
then the new interest rate = 5% + 3% = 8%.
If the periodic cap is 1% then
the actual new interest rate will be 6% + 1% = 7%.

Your mortgage disclosure will tell you the exact index, to be used, whether the weekly or monthly value applies, the lead time for your index, the margin, and any caps.

Negative Amortization Loans

Some types of ARMs offer payment caps rather than interst rate caps, which limit the amount the monthly payment can increase. If a loan has payment cap but has no periodic interest rate cap, then the loan may become negatively amortized: if the interest rates rise to the point that the monthly mortgage payment does not cover the interest due, any unpaid interest will get added to the loan balance, so the loan balance increases. However, you always have the option to pay the minimum monthly payment, or the fully amortized amount due.

Example:

Your loan has a payment cap of 7.5%. If your payment is $1,000 per month and interest rates rise, your new payment would normally be $1200/mo (for example). But your capped payment is only $1075. The other $125 get added to your loan balance, to be paid off over time, unless of course you decide to pay that additional amount now.

The advantage of negatively amortizing loans is that you can control cash flow (relatively stable payment), take advantage of low interest rates relative to the market at any given time, and pay back the money borrowed today at a depreciated value years from now (because of natural inflation). This makes such loans a great tool for homeowners as long as you understand the mechanics of what's going on.

With most ARMs, the interest rate can adjust every six months, once a year, every three years, or every five years. The interest rate on negatively amortized loans can adjust monthly. A loan with an adjustment period of 6 months is called a 6-month ARM, with an adjustment period of 1 year is called a 1-year ARM, and so on.

Most ARMs offer an initial lower interest rate than the fully indexed rate (index plus margin) during the initial period of the loan, which could be one month or a year or more. It is also known as teaser rate.

All ARMs are available with 30-year terms and some with 15-year terms.
Adjustable rate mortgages generally have a lower initial interest rate than fixed rate loans.

With fixed-period ARMs homeowners can enjoy from three to ten years of fixed payments before the initial interest rate change. At the end of the fixed period, the interest rate will adjust annually. Fixed-period ARMs -- 30/3/1, 30/5/1, 30/7/1 and 30/10/1 -- are generally tied to the one-year Treasury securities index. ARMs with an initial fixed period beside of lifetime and adjustment caps usually have also first adjustment cap. It limits the interest rate you will pay the first time your rate is adjusted. First adjustment caps vary with type of loan program.

The advantage of these loans is that the interest rate is lower than for a 30-year fixed (the lender is not locked in for as long so their risk is lower and they can charge less) but you still get the advantage of a fixed rate for a period of time.

Two-Step mortgages have a fixed rate for a certain time, most often 5 or 7 years, and then interest rate changes to a current market rate. After that adjustment the mortgage maintains new fixed rate for the remaining 23 or 25 years.

Some ARMs come with option to convert them to a fixed-rate mortgage at designated times (usually during the first five years on the adjustment date), if you see interest rates starting to rise. The new rate is established at the current market rate for fixed-rate mortgages.

The conversion is typically done for a nominal fee and requires almost no paperwork. The disadvantage is that the conversion interest rate is typically a little higher than the market rate at that time.

The other kind of convertible mortgage is a fixed rate loan with rate reduction option. If rates had dropped since the time of closing it allows you, under some prescribed conditions, for a small conversion fee to adjust your mortgage to going market rate. Generally the interest rate or discount points may be a little higher for a convertible loan.

Buydown Mortgage

A temporary buydown is the type of loan with an initially discounted interest rate which gradually increases to an agreed-upon fixed rate usually within one to three years. An initially discounted rate allows you to qualify for more house with the same income and gives you the advantage of lower initial monthly payments for the first years of the loan when extra money may be needed for furnishings or home improvements. To reduce your monthly payments during the first few years of a mortgage you make an initial lump sum payment to the lender. If you do not have the cash to pay for the buydown, the lender can pay this fee if you agree on a little higher interest rate.

A very popular buydown is the 2-1 buydown.

Example

If the interest rate on the note is 8% with a 2-1 buydown mortgage your initial discounted rate is 6% and you would have 6% interest rate for the first year, 7% for the second year, and 8% afterwards. You will need to prepay the difference in payments between the 6% and 8% rates the first year, and between the 7% and 8% rates the second year.

3-2-1 and 1-0 buydowns are also available, though less common. Compressed Buydown, works the same way, but with the interest rate changing every six months instead of on a yearly basis.

The lower rate may apply for the full duration of the loan or for just the first few years. A buydown may be used to qualify a borrower who would otherwise not qualify . This is because a buydown results in lower payments which are easier to qualify for.