Various Types of Mortgage
A mortgage involves the conveyance of an interest of the property such as land or real estate assets as protection for a borrowing that happens between the mortgagor (the borrower) and the mortgagee (the lender). There are various classifications of mortgages available, both for commercial and residential real estate purposes. The following discussions are on these variations on residential and commercial mortgage types with accompanying tabular representation of the advantages and disadvantages on the respective side of the borrower and the lender.
I. Fixed Rate Mortgage
A fixed rate mortgage, as the name says it, is a mortgage with a static rate of interest. This rate is being laid out at the commencement of the loan and for the entire life of the mortgage, this “rate does not change” (Types of Mortgage). This means that a loan agreement for twenty (20) years with 24% annual interest will have an interest rate of 24% for each year in 20 years of that agreement’s life.
There are two other types of fixed rate mortgage, aside from the general type. These are the “interest-only fixed rate mortgages” and “biweekly mortgages.” These two however are not available to all the borrowers. The term of the loan in an interest-only mortgage is divided into two periods. The monthly payments for the first half of this period are lower without paying the principal, and only the interest is being paid For the rest of the period, both the principal and the interest are being paid increasing the amount of payments tremendously. In a biweekly mortgage” the loan is paid faster because the payment is every two weeks for the half of the monthly payable resulting to a total of twenty-six (26) payments in a year” (Types of Mortgage).
Table 1. Fixed-Rate Mortgage Effects Borrower Lender
1.Inflation Protected – helps the borrower own the property in the long-term because the payments stay no matter how the inflation rises
2. Long-term feasibility – fixed expenses each month enables the borrower to control expenses and plan for other purchases
3. Low risk – the mortgage payment stays the same no matter how and what the current rate is.
1. The chance of imposing a “higher than market” rate to the borrowers.
2. Receivables are on a steady basis even the interest rate goes down.
1.Initial interest rates are usually higher than the market rate due to the inherent risk to the lender
2. No possibility of reducing the rate even the interest rates fall down the original rate unless it is refinanced.
3. Taxes and insurance changes can still make the monthly payments fluctuate
1. The risks of rising interest rate, which the case more often than not.
2. The borrower pays the same amount all the same even the interest rates go up.
The greater advantage is on the side of borrowers. Even though lenders impose greater interest rate at the beginning there is not a heavy risk to worry about. Interest rates, more often than not, is rising and not falling.
II. Adjustable Rate Mortgage
With the adjustable rate mortgage or simply ARM, a fixed initial rate of interest is provided as well as fixed monthly rate of payment at the beginning. This fixed rate however is only for a short period of time, can be from within six (6) months up to six (6) years. After this fixed period, the rate of interest as well as the monthly mortgage payments may fluctuate in reference to the current market rate. The adjustment period determines the frequency of interest rate changes that the borrower must pay. This type of mortgage is more popular due to its lower beginning rate. It very risky in the part of the borrower though.
Table 2. Adjustable rate Mortgage (ARM) Effects Borrower Lender
1.Interest rates are usually lower than the market rate at the beginning
2. Has the possibility to reduce the rate when the current rate fall down the original rate.
3. The adjustment period buffers the quick rise in interest rate in case of increasing current rate of interest.
4. The presence of caps or ceiling which limit the amount level of interest increases
1. No heavy risks involve
2. The presence of caps/floor allows a limited decrease in interest rate in case the current rate fluctuates downward.
3. Interest rates often rise than fall
1. Big risk is involve in the fluctuating market rates
2. Difficulty and uncertainty in determining the amount to be paid in the future
3. Very unlikely decreases in the current rate and more probability of increasing the current rate of interest causing a need to increase the monthly payments to lenders
1. The possibility presence of caps still limit the increase in interest rate
2. Possibility of reducing the interest that can happen when adjusting with the current rate
3. Adjustment periods deter the immediate increases in interest rates when the current rate fluctuates higher
4. Lower interest income at the beginning of the mortgage period
More advantage in this type of mortgage is in the side of the lenders who assume very little risk. The previous matrix also shows how it can be disadvantageous to borrowers.
III. Balloon or Reset Mortgage
A thirty (30)-year amortization timetable is present in the balloon/reset mortgage option. Unless the borrower opts to reset the mortgage, the full balance, called the “balloon” is payable at the end of the five (5) or seven (7) -year periods. This is often believed to be a “two-step” type of mortgage because the borrower can either pay the loan or exercise the reset option when the agreed term matures. This also offers a lower interest rate and the possibility of setting the interest rate in line with the current rate during the reset. The option to reset, however, has some specific requirements that need to be complied with by the borrower before they are approved to do the action.
Table 3. Balloon/Reset Mortgage Effects Borrower Lender
1.A good option when planning to sell the property (house/residential property) before the maturity
2. Initial interest rate is lower
3.Gives greater chance to qualify for a higher mortgage/loan amount
1. The amount of principal lent is recovered quickly while there is no heavy risks involved
2. Lower cash receipts can be compensated by the “balloon”
3. No caps or borrower protection in adjusting the interest rate when the rates “explode”
1. A strict compliance with the reset requirements is a must if planning to refinance or reset the mortgage
2. A greater possibility of increasing rate causes greater payments during the refinancing period
3. Big risks
4. The “balloon” amount is very heavy to pay unless refinanced
1. Lower cash receipts during the initial period due to lower monthly payments by the lender
2. Taken for granted by borrowers by “going away” from the house/property before the “balloon” period.
Greater advantage of this scheme can be taken for granted by borrowers who are serious to be “away” of the property before the “balloon” period.
IV. Reverse Mortgages
The type of mortgage that is intended to be more attractive for older property owners is called the reverse mortgage. Comparably, his type of mortgage in newer in the market than those previously discussed. As the name suggests, the reverse mortgage applies the mortgage concept in a “reversed” manner. While the property owner pays the lender in normal mortgage, the property owner receives cash that need not be paid until he/she dies or does not make the property/home his/her principal residence.
Table 4. Reverse Mortgage Effects House/Property Owner Payer
1.A good source of income and a supplement to retirement benefits
2. Favorable to those homeowners who have good equity in their property/house
3.No payments needed
1. A very popular and salable scheme
2. Advantageous in both ways: the shorter the loan is repaid, the safer and the longer it is repaid, the more interest earned.
1. A strict qualification of at least 62 years of age
2. A necessity to stay at home
3. Disadvantages to children of house owner after death
4. Susceptible to fraud since the involved are older individuals and the scheme is relatively new
5. Initial fees required such as origination fees, appraisal, service and other fees
1. A return on the money loaned cannot be received until the homeowner’s death or until he/she leaves the house
This mortgage type can help and is advantageous to old individuals who need money for their old age, which, more often than not, carry health problems. Reverse mortgage can assist financial needs when needed.
The above types of mortgages are available for residential/house properties and the following discussions are on commercial real estate mortgages.
Commercial mortgages, especially in real estate, have similar concept as with the residential ones except that they are applied in commercial buildings such as shopping centers, office and industrial buildings, resorts, hotels, golf course, parking garages, and construction loans to name a few. Following are the various commercial real estate mortgages available together with the matrices on their respective effects on the side of the borrower and lender.
I. Fixed Rate Commercial Mortgage
The fixed rate commercial mortgage applies the same idea with the fixed rate mortgage. However, in this case, it is a commercial funding typically involving properties like multi-family, anchored, unanchored retail, full and limited service hotels, offices, light-industrial, self-storage, and senior housing. The loanable amount in this case is subject to the underwriting criteria with a usual term of 5 to 20 years.
If this kind of mortgage is taken, factors such as prepayments, assumptions, liability and amortization all need to be discussed between the lender and the borrower. For the advantages and the disadvantages of this kind of mortgage, since it is generally similar to fixed rate mortgage, please see Table 1.
II. Adjustable Commercial Mortgage
Adjustable commercial mortgage, simply stated has the same principles with ARM, except that this one is for commercial purposes and the other is for residential. The interest rate for this type of mortgage periodically changes in accordance with the agreed index between the lender and the borrower.
The usual programs involved in this mortgage scheme include: (1) “Easy in/ Easy out; (2) variable or convertible loan; (3) Adjustable loan with a future choice to increase the borrowed amount; and (4) simple interest loans, either with or without graduated payments. To determine the benefits and risks of this mortgage scheme to others, especially the fixed commercial rate, information on indices, margins, discounts, cap structures, negative amortization and convertibility are all necessary. Generally however, the pros and cons factors can be parallel to that of ARM in Table 2.
III. Participating Mortgage
Participating mortgage is considered as a “creative business financing alternative” (Participating Mortgage). It is a loan that may allow lender to participate or share with the property’s earnings/revenues. This is based on the clause and conditions of the contract, which also contains the degree of participation, which can be any, or a combination of the amount of gross receipts, operating or net income or the property’s cash flows.
Table 5. Participating Mortgage Effects Property Owner Lender
1. With better business and financial tract, this kind of mortgage is easier to obtain
2. A good alternative for financing purposes
1. A more secure way to give loan
2. Offers flexibility in loan structuring
3. Spread and reduced risk
4. Two ways to earn: both from interest and principal and as well as from the percentage of participation
1. The feasibility and percentage of sharing will be based on performance records
2. Lender’s sharing rate may be too high
3. Unfavorable to problematic business
4. The interest must still be paid
1. The borrower may not perform very well giving lesser returns.
This participating mortgage scheme is more advantageous in the part of the lender because they can also choose a good performing business or property when giving the loan.
IV. Second Mortgage
Second mortgage is considered as an “important real estate tool” (Second Mortgage). Since it is a “second mortgage”, it is usually utilized in conjunction with a “new first loan” (Second Mortgage). Its term is usually less than five years with interest only payments. It is a very important consideration for the borrower because the loan, after the second mortgage, is already two. Most borrowers in this case opt for the reduction of the loan to value (LTV) of the first loan, which makes them better qualified for the second loan. The terms are also flexible such as interest only payments, annual payments and exit that may help the payment options easier.
Table 6. Second Mortgage Effects Property Owner Lender
1. Chance to have additional financing when needed
2. Can utilize the LTV
3. A chance to let the property appreciate before paying further
4. Gives flexibility in mortgage terms
1. A good way to earn interest
1. Makes the loan very big and might compromise the property
1. Property has already previous liens (the first lender).
Second mortgage is obviously more advantageous on the side of the borrower as shown in the above table. It gives little benefit to the lender aside from the interest that would be earned from loaned principal. Generally however, mortgages have advantages on both parties. To perfectly utilize its benefits, borrowers must have, according to Ratcliffe, Stubbs, and Shepherd, (2003) a “mix of different types of finance which is essential to the well-balanced portfolio and a combination of part variable-rate and part fixed-rate mortgage” that will enable the “borrower to take advantage of any further fall in interest rates while protecting against an increase”.
The borrowers must really be careful with their financing options though. It can harm the property if it is not done correctly and with utmost care. In fact "over the 1990-2000 period, on average, 51.04% of delinquent properties are in the process of foreclosure, that is, the loans are not being reorganized." (Brown) Mortgages can help but in some ways, it can worsen the problems as well.
Brown, David T. "Call Options and Liquidation in Commercial Mortgage Financing." Real Estate Economics 30.1 (2002): 115+. Questia. 20 May 2008 <http://www.questia.com/PM.qst?a=o&d=5000734055>.
“Participating Mortgage.” Business Finance, 2008. 19 May 2008. <http://www.businessfinance.com/participating-mortgage.htm>
Ratcliffe, John, Michael Stubbs, and Mark Shepherd. Urban Planning and Real Estate Development. New York: Spon Press, 2003. Questia. 20 May 2008 <http://www.questia.com/PM.qst?a=o&d=108459562>.
“Second Mortgage.” Business Finance. 2008. 19 May 2008 from <http://www.businessfinance.com/second-mortgage.htm>.
“Types of Mortgage.” Find Law for the Public. 2008. 17 May 2008. <http://realestate.findlaw.com/buying-home/buying-home-mortgages-loans/types-of-mortgages.html >