John Harris is a researcher and writer on applicable real estate topics such as economics, credit improvement tips, home selling advice and home buying preparations. For more information please visit Del Mar Realtors
Whether your are obtaining a mortgage for your first home, or your tenth in a series of real estate investments, the type of mortgage you choose will have a lasting impact. The consistency of your payments, the amount of interest you pay, and the amount of money you put down will all affect your decision. Here’s a quick glossary of the terms you need to know.
Fixed vs. Variable Mortgage Loans
The standard 30 year fixed real estate mortgage isn’t so standard anymore. It’s still extremely popular because you can lock in a one-time interest rate that will stay consistent over the life of your mortgage. But this doesn’t work for everyone, which is why the other real estate mortgage options have evolved.
The variable mortgage, also called an adjustable rate mortgage (ARM), or floating mortgage, is often attractive because the payments and interest rates can be significantly lower. The problem is that the interest rate will fluctuate along with the prime lending rate. This means your mortgage payment could increase at any time. This is a good option only if you know you can handle the jump in payment without consequence.
Interest Only Mortgage Loans
If you have ever looked at the amount of interest and principle paid on an actual real estate mortgage payment, then you know why interest only loans are so popular. Someone who pays $1,250 monthly, at a 5.875% interest rate, is actually making a payment of about $670 to interest, $400 to escrow, with only $180 going towards paying off the principle of the loan. By paying off the interest in the early years of the loan, your monthly payment will be significantly lower. A traditional mortgage would require that additional payment to principle each month.
While your payments with an interest only real estate mortgage loan are guaranteed to jump once the interest is paid off, this can work towards your advantage in some situations. For instance, a young person just starting out in a career may expect to be making more money by the time the monthly real estate payment increases. Also, the flexibility can allow you to borrow more money, or create more cash flow in your real estate investment, in those early years.
On the down side, you don’t accrue any real estate equity when you’re not paying off the principle amount owed. Also, the unpredictability of the real estate market makes this a riskier loan. Most financial advisors also counsel against taking out an interest only loan if you can’t afford the house without it.
Negative Amortization
A negative amortization loan is most often used in areas where real estate costs are very high, with the goal of helping people who could not otherwise afford to buy into the area. Basically, the real estate lender agrees that the mortgage holder will pay less than the amount of interest due each month for a short, usually 5 year, period of time. The owed amount is tacked on to the remaining real estate loan at the end of that period. Also known as a deferred interest or Graduated Payment Mortgage (GPM), this is considered risky since the “jump” at the end of the lower payment period will be significant.
Balloon Mortgages
Balloon Mortgages have inspired come controversy in the real estate industry, because some shady real estate professionals have advised them inappropriately. With a balloon mortgage, you pay a fixed rate for a specified period of time (5/7/10 years) and then pay off the remaining principle in a lump sum when that time is up.
Balloon mortgages are attractive because the interest rates are usually lower. One way to use a balloon mortgage for your real estate purchase is to take advantage of the lower interest rate, and then attempt to refinance at a low fixed rate at the end of the term. This is especially appealing when interest rates are high. Just remember, have a plan, and a back up plan, for paying off the final amount if you are thinking about a balloon mortgage.
The best advice is probably to talk to someone you trust who has a good real estate background, and who can assess your specific situation. Every real estate transaction is different, and so are your mortgage needs.
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