Loan and mortgage types that fit your needs the best


What is a balloon loan?

Balloon mortgages, also called partially amortizing loans, offer monthly payments calculated as if the loan would be fully amortizing, but the entire principal balance will be due in a shorter time, usually five, seven, or ten years. Commercial lenders will usually say, "I can offer you a ten-year loan on a thirty-year am," meaning a ten-year loan but with monthly payments calculated is if it were a thirty-year loan. Residential lenders usually call this a balloon mortgage. You can usually obtain somewhat cheaper rates with balloon loans than if you had a fully amortizing thirty-year loan.

Often, you have the option to convert the loan to a regular mortgage at the market rate for thirty-year loans, plus a little bit of extra interest, usually 3/8%. If you have a five-year balloon with a conversion option, the loan is called a 5/25 Convertible. For seven-year balloons, it is called a 7/23 Convertible.

What is the difference between an adjustable rate mortgage and a variable rate mortgage?

Home lenders generally offer adjustable rate mortgages. Business lenders (those who loan to flippers or rental income investors) usually offer variable rate mortgage loans. An adjustable rate mortgage (ARM) changes interest rates only on certain anniversary dates, such as once every six months or once per year.

Variable rate loans change interest rates every time the index changes. If your variable rate loan is based on something called the 11th District Cost of Funds Index, then every single time that rate changes, your loan interest will also change. That means your payments could be different amounts every month. Many times, variable rate loans have a floor, which means your interest rate may not decrease below a certain percentage, even if the index rate drops dramatically.

How can I protect myself against high interest rates under an ARM?

You should make sure that your ARM has interest rate caps. This is a promise by the lender that interest rates will not increase more than a certain percentage each year, and will not increase more than a certain percentage over the lifetime of the loan. Not all ARMs have such caps. Almost no variable rate loans have caps.

Does an ARM payment cap protect me against high payments?

Some ARM loans have payment caps, meaning your monthly payment cannot increase above a certain amount, even if the interest rate rises sharply. The danger is something called negative amortization. Suppose your payment cap is US Dollars 500 per month, but your interest rate increase should have resulted in a payment of US Dollars 550 per month. Your lender does not just forgive the extra US Dollars 50 in interest.

No, your lender takes that US Dollars 50 per month out of your equity! Rather than amortizing your loan so the principal balance gets lower each month, you are negatively amortizing and your principal balance is getting higher every month.

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Note: This article was sent to us by: Nathaniel D. Wadross at 06262010

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