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Mortgages Vary like the Wind

Posted by  on Apr 16, 2009
 
Mortgages may seem like a simple concept at first glance, however, it becomes more obscure when you take the time to understand the various types of existing mortgages. Mortgages are just temporary, pledges of property to a creditor that acts as a security for the performance of an obligation or the repayment of a debt. There are many types of mortgages used worldwide, but several factors broadly define the characteristics of the mortgage. All of these may be subject to local regulation and legal requirements.

The two main kinds of loans are fixed rate mortgage (FRM) and adjustable rate mortgage (ARM). In many countries, floating rate mortgages are the norm and will simply be referred to as mortgages. Combinations of fixed and floating rate are also common, whereby a mortgage loan will have a fixed rate for some period, and vary after the end of that period. In the U.S., the term is usually up to thirty years, although longer terms may be offered in certain circumstances. For a fixed rate mortgage, payments for principal and interest should not change over the life of the loan, although ancillary costs and do change.

With adjustable rate mortgages, the interest rate is generally fixed for a period of time, after which it will periodically, adjust up or down to some market index. Adjustable rates transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where fixed rate funding is difficult to obtain or prohibitively expensive. Since the risk is transferred to the borrower, the initial interest rate may be from 0.5% to 2% lower than the average 30-year fixed rate; the size of the price differential will be related to debt market conditions, including the yield curve.

The higher the score, the more creditworthy the borrower is assumed to be. Favorable interest rates are offered to buyers with high scores. Lower scores indicate higher risk for the lender, and higher rates will be charged to reflect the higher default rates.

A balloon loan is one where the amount of monthly payments due are amortized over a certain term, but the outstanding principal balance is due at some point short of that term. This payment is sometimes referred to as a "balloon payment" or bullet payment.

Though balloon loans are usually identified by the fact that the full amount of the loan is turned over when the contract is signed, but only the interest is paid off during the life of the loan, with a "balloon" payment of the principal due on the final day. Sometimes, a lender will offer a loan in which both interest and principal are paid with a single "balloon" payment. Balloon loans are usually reserved for situations when a business has to wait until a specific date before receiving payment from a client for its product or services.

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