There are many types of mortgage loans. The two basic types of amortized
loans are the fixed rate mortgage (FRM) and adjustable rate mortgage
(ARM).
In a FRM, the interest rate, and hence monthly payment, remains
fixed for the life (or term) of the loan. In the U.S., the term is
usually for 10, 15, 20, or 30 years (15 and 30 being the most common).
The only increase a consumer might see in their monthly payments
would result from an increase in their property taxes or insurance
rates (paid using an escrow account, if they've opted to use an escrow).
But payments for principal and interest will be consistent throughout
the life of the loan using an FRM.
In an ARM, the interest rate is fixed for a period of time, after
which it will periodically (annually or monthly) adjust up or down
to some market index. Common indices in the U.S. include the Prime
Rate, the London Interbank Offered Rate (LIBOR), and the Treasury
Index ("T-Bill"). Other indexes like 11th District Cost
of Funds Index, COSI, and MTA, are also available but are less popular.
Adjustable rates transfer part of the interest rate risk from the
lender to the borrower, and thus are widely used where unpredictable
interest rates make fixed rate loans difficult to obtain. Since the
risk is transferred, lenders will usually make the initial interest
rate of the ARM's note anywhere from 0.5% to 2% lower than the average
30-year fixed rate.
In most scenarios, the savings from an ARM outweigh its risks, making
them an attractive option for people who are planning to keep a mortgage
for ten years or less.
Additionally, lenders rely on credit reports and credit scores derived
from them. 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 to the lender,
and lenders require higher interest rates in such scenarios to compensate
for increased risk.
A partial amortization or balloon loan is one where the amount of
monthly payments due are calculated (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". A balloon loan can be either a Fixed or Adjustable
in terms of the Interest Rate. Many Second Trust mortgages use this
feature. The most common way of describing a balloon loan uses the
terminology X due in Y, where X is the number of years over which
the loan is amortized, and Y is the year in which the principal balance
is due. A contract could be written up so there would be more than
one "balloon payment" required to be paid during the life
of the loan.
