Legal Forms and Documents: Types of Real Estate Mortgages for Home Buyers and Landlords.

Most people buy a home for themselves or property to rent out as a landlord by proving that they have a good financial record and stable employment in order to qualify for a bank mortgage. Once a mortgage has been awarded the debt is secured by the lender through having the legal right to keep or sell the property if payments on the loan have defaulted. The owner of the property also has the same rights providing the terms of the mortgage contract agreement have not been broken.

Mortgages are normally paid by monthly installments which has two components: (a) Bank Interest Rate and (b) Capital Payment. The bank interest paid on the loan keeps the amount borrowed stable and the capital payment reduces the amount borrowed and has the affect of increasing collateral in the property providing that the property is not experiencing negative equity due to either a declining maket, poor building maintenance or a rising loan.

There are numerous types of mortgage loan mechanisms available as follows:

With a straight repayment mortgage the loan is paid monthly in two components : Interest is an amount that is calculated on a variable interest rate derived from the Federal Reserve bank rate and a smaller part at the beginning of the loan term pays into the capital part of the loan thus reducing the amount borrowed each month or every time a payment has been made. And counter-balances the interest paid which reduces and contributes to the capital part of the loan. So over a period of time the interest element of the mortgage reduces and the colateral element value increases if payments have not been interrupted.

It may be interesting to note that with repayment mortgages lumps sums or regular extra payments being made reduces the overall term of the mortgage during times of relative prosperity. But with some mortgages a penalty clause will appy if the mortgage loan is paid-off early. In that event it is worth checking with the mortgage provider if penalties will be imposed and if it is advisable to restructure the mortgage payments at a lower rate of payment which is sometimes called a pepper-corn rate of repayment. So that the full term of the mortgage is realised to avoid costly penalty charges for early settlement of the loan.

Another type of penalty can arise if regular payments are interrupted and that can in some instances attract very high interest rates that compound up month on month and if left unchecked can rapidly erase the capital value of the property and in extreme cases put the property into the realm of negative equity. Making the property worth equal or less than the loan attracting a high possibility of reprocession by the lender. When payments are not made some lenders take the view that the loan is being extended without an agreement or arrangement and then a higher rate of interest is imposed until the loan has been normalized within the original terms.

Often this can be avoided; if the owners of the house mortgage know that they will default on the loan for a short time but have had a good past record and a plausible future plan then they can often enter into an arrangement with the lender for upto six months to avoid penalty rates of interest. It is really worth having a discussion with a mortgage provider if difficulties arise to avoid compounding interest rates and the potential consequential problems that come out of that type of circumstance.

Before entering into a mortage contract which is often a very long term commitment read the terms and conditions of the agreement and most especially the penalty clauses and make a judgement whether the lender is willing to negotiate if difficulties arise; this will help to avoid lenders who have very tight conditions.

Also check in the terms of the mortgage to see if the property insurance that the lender provides is automatically added to the mortgage each year; in the event that the insurance premium is added each year then the term of the mortgage can be greatly extended because the capital payments are reduced. Make an arrangement where the home insurance is paid concurrently each month to avoid this pitfall. In every instance of arranging a property mortgage check this feature because it can cost many extra years of mortgage payments because it impacts the early years of the loan.

During a 30 year lifespan of a typical mortgage interest rates fluctuate as the western worlds economic fourtunes change through cycles of prosperity and recession and sometimes at a frequency of every 18 years economic resession turns into economic depression. Most people would prefer to have a flat earth economy when it comes to borrowing money for major purchases such as real estate and for that reason financial institutions offer Fixed Interest Rate Mortgages because it is easier to plan personal resources. But when a person or business takes out a fixed interest rate mortgage they are actually placing a bet in the money markets against the lender that interest rates will in the long term rise. But if an error of judgement has been made then the mortgage will be more expensive but only with the benefit of hindsight and so this type of arrangement is a gamble. But it does give a measure of assurance of having fixed and predictable out-goings over a very long period of time.

Banks often fix the interest rate above the base rate when the loan has been awarded and this can be between 1%-4% above the base rate depending on whether the loan is for a private individual who is buying a home or a business. In either circumstance always negotiate and if a mistake is realised through future long term 5 year trends then the mortgage can be changed into a different form or moved to another lender poviding penaly costs are not prohibitive.

This type of mortgage combines features of the fixed rate mortgage and the straight/ variable rate mortgage by fixing the intial fixed rate term for a period from 6 months to a maximum of 6 years. After the fixed rate of interest period has expired then the interest rate becomes flexible and follows market trends. But if this type of mortgage is used as a low start mortgage payment model then the interest rate can rise to very high rates to compensate the lender for actually lending initally below market interest values. Thus the advantage of cheap borrowing is lost after the fixed interest rate period; for some this has proved to be a financial time-bomb that has led to property reprocession.

It is also worth enquiring of the lender how the loan interest rate is calculated; some calculate the interest every 3 months and some 12 months and then they add the shortfall of interest payments retrospectively to the mortgage; this gives the borrower interest rate smoothing and the lender higher profits. Arrangements that should be avoided are those that use monthly compound interest rate calculations where interest is paid on interest payments which can in some circumstances equate to double payments. Again always check the terms and conditions of a loan before committing.

Also check the terms of the mortgage to see if the property insurance that the lender provides is automatically added to the mortgage each year; in the event that the insurance premium is added each year then the term of the mortgage can be greatly extended because the capital payments are reduced. Make an arrangement where the home insurance is paid concurrently each month to avoid this pitfall.

This type of mortgage is often a last resort type of mortgage for people who cannot qualify for a usual run-of-the-mill property loan., but this solution has it’s own positive as well as negative attributes.

The way it operates is that the lender provides an interest rate only repayment plan often linked to a pension or other investments that pay the capital part of the loan when it matures; for this reason it is often referred to as a Baloon Payment Mortgage. Before entering into this type of contract it is worth enquiring whether capital payments can be made during the term of the mortgage to reduce the future burden of a large lump sum payment at the end of the term. If that is not possible then the loan has to be re-negotiated and implemented to retain the property or the entire loan is paid from personal or business investment securities such as a pension.

This is an interesting mechanism that is used by home owners and sole proprietors for raising investment capital from capital paid into a real estate mortgage. The mortgage may attract tax benefits because it is a new and separate arrangement from the mortgage but it is secured by the real estate which is supporting the loan. This can also be used as a business loan or a home improvement loan and some people use it as a lump-sum payment into a Self Invested Personal Pension, (SIPP) because the SIPP can get a higher rate of investment interest paid into it each month. When an Equity Release Loan is taken out the duration of the mortgage can either remain the same but with much higher monthly repayments or a compromise solution can be adopted by extending the term of the mortgage to make the repayments more affordable for many. But there is a health warning for some people who as married couples agree to further the business interests or aspirations of a partner by allowing an equity release loan as business finance only to find that soon affterwards they are facing divorce proceedings. And have lost equity in their share of the family home that is difficult to recover without an Attorney unless they have a stakeholding or shareholding in the business entity that has recogniseable material and saleable assets.

The home equity credit line interest rate is normally derived from the national variable prime rate that is published by banks and newpaper publications. The interest rate for borrowing under this scheme is often at a margin above the base rate which can be from 1%-4% above base depending upon the purpose of the loan and whether it is an equity release for the purpose of rasing capital for a business.

Costs of Setting-up an Equity Release Loan

Banks and other Lenders charge an arrangement fee for this type of loan which typically comprises:

Application Fee, Property Surveyors and Evaluation Fee, Title Search Fee, Attorney’s Fee, Property and Title Insurance Fees. Other micellaneous fees may include reoccurring maintenance or account review fees. It can be appreciated that setting-up this type of line of credit can be expensive but those costs are offset and are justified by having a more favorable interest rate that other types of loan.

The Second Mortgage Loan differs from an Home Equity Release loan because it is treated like a normal or traditional loan that is more expensive because it not only attracts more charges to set-up. It also attracts a higher rate of interest which is based on the base rate plus some extra basis points of interest for the entire duration of the loan. The Equity Release loan is just based on the periodic interest rate without additional basis points of interest added.

A reverse mortgage operates like a traditional mortgage except in reverse; the equity in the home is paid back to the retired homeowner either in regular monthly payments or as a cash lump sum. No repayments are made to the financial institution but the real estate becomes the property of the institution when the property is no longer being used by the homeowner. The way the financiers make their money is that they do a valuation on the property and lend typically 50% of the market value in the expectation, that is not without risk, that the property will be worth more when the retired owners have died so as to release the property onto the market for sale by the lender to realise the capital. This scheme works well if property market values have peaked or are just off their peak but it is an unattractive scheme for people entering retirement during recessionary times. If this type of property is left in a Last Will or Revocable Trust then those arrangements are null and void because this property arrangement allows the company who loans money to have possesion of the real estate after the death of those who made the arrangement. Unlike a pension scheme where 50% of the residual pension value left is paid to the persons beneficiaries.

This federal act requires lenders to allow a 3 day cooling-off period for the customer to decide to either keep the loan or to cancel the loan. In the event thatthe loan is cancelled in writing within the three days after the agreement has been made then the lender has to return it’s security interest in the property and all fees charged. The truth in Lending Act requires the lender to reveal  terma and conditions of the loan, costs of home equity plans, fixed or variable interest charges and repayment terms.