Mortgage loan types

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. 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.

Mortgage loan process

In the U.S., the process by which a mortgage is secured by a borrower is called origination. This involves the borrower submitting an application and documentation related to his/her financial history and/or credit history to the underwriter. Many banks now offer "no-doc" or "low-doc" loans in which the borrower is required to submit only minimal financial information. These loans carry a slightly higher interest rate (perhaps 0.25% to 0.50% higher) and are available only to borrowers with excellent credit.

Sometimes, a third party is involved, such as a mortgage broker. This entity takes the borrower's information and reviews a number of lenders, selecting the ones that will best meet the needs of the consumer.

Loans are often sold on the open market to larger investors by the originating mortgage company. Many of the guidelines that they follow are suited to satisfy investors. Some companies, called correspondent lenders, sell all or most of their closed loans to these investors, accepting some risks for issuing them. They often offer niche loans at higher prices that the investor does not wish to originate.

If the underwriter is not satisfied with the documentation provided by the borrower, additional documentation and conditions may be imposed, called stipulations. The meeting of such conditions can be a daunting experience for the consumer, but it is crucial for the lending institution to ensure the information being submitted is accurate and meets specific guidelines. This is done to give the lender a reasonable guarantee that the borrower can and will repay the loan. If a third party is involved in the loan, it will help the borrower to clear such conditions.

The following documents are typically required for traditional underwriter review. Over the past several years, use of "automated underwriting" statistical models has reduced the amount of documentation required from many borrowers. Such automated underwriting engines include Freddie Mac's "Loan Prospector" and Fannie Mae's "Desktop Underwriter". For borrowers who have excellent credit and very acceptable debt positions, there may be virtually no documentation of income or assets required at all. Many of these documents are also not required for no-doc and low-doc loans.

Mortgage information excerpted from Wikipedia