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Loan Options

There are literally dozens, if not hundreds, of different loan options, but the most common fall into two basic types: fixed rate and adjustable rate as described below.
Conforming or Jumbo? The government pitches in
There are two quasi-governmental finance agencies, The Federal National Mortgage Association (FNMA, or "Fannie Mae") and the Federal Home Loan Mortgage Corporation (FHLMC, or "Freddie Mac"), whose only purpose is to ensure the nationwide availability for funds for home mortgages, thereby enabling a higher percentage of home ownership. They do this by buying mortgages from mortgage bankers, which replenishes the money supply and encourages more home-loan lending. Their current limit on mortgages is $240,000 (as of January 1, 1999). A conforming loan is a first mortgage up to that amount, and a jumbo loan is a first mortgage greater than that amount.

Since mortgages under $240,000 can be sold to a low-cost source, they will naturally cost less to you the borrower. Conforming loans, particularly fixed-rate loans, are generally cheaper.

Free Lunch: there ain't no such thing
You have seen advertisements for loans starting as low as 4%, haven't you? You have seen the same for "no-point, no fee" loans. Or how about adjustable-rate loans that are convertible to a fixed-rate loan? Are these great deals? They might be, depending on your circumstances and needs. But please ask careful questions of any lender. There are fabulous features to every loan, but no loan has all the best features. (If it did, everyone would get that one loan.) What is right for you? Please take the time to understand these programs, what they do and what they don't offer, and you'll be able to help us help you better.
Cost/Interest Rate: the tradeoff
The incidental costs of a loan (appraisal, title insurance, escrow fees, processing) will be about the same no matter which program you choose (even a no-point, no-fee loan; see below to learn why). Points, the money the broker and lender earn for putting the loan together can vary even with the same loan program, depending on the starting rate you choose. For instance, if you get a new loan at 8% interest and one point, you might be able to get that same loan at 7.5% interest and two points. (One point equals 1% of the loan amount. Points are also known as an origination fee.) When we use the term cost below, we mean the total of points and incidental costs.
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No-Point, No-Fee Loans
On most of the loans we offer, you may choose higher up-front fees for a lower rate, or vice-versa. In other words, you may choose a lower interest rate by accepting higher points. You might get the same loan at, for example, X - 0.4% and Y + 0.5 points; the relationship varies daily, so it is not always a consistent ratio.

If you wish to pay less in up-front fees, we can offer you that too, by increasing the interest rate. At some point the lender will actually pay part or all of our fees; if they pay all of our fees, it is a no-points loan.

With some but not all programs, when the rate gets high enough the "rebate," as it is called, from the lender may get high enough to pay for our fees plus all of your closing costs. Thus, a "no-point, no-fee loan." On a 30-year fixed-rate mortgage, this might be at an interest rate 1.25% to 2% higher than the same loan at full cost plus two points, so it's not really a no-cost loan.

  • Advantages: No costs at all up front, though we do collect appraisal and credit-report fees up front and refund them in escrow.
  • Disadvantages: Higher interest rate on the loan.
When it is a good idea:
  • (In case of a purchase) When you have very little to put down, but your income is sufficient.
  • (In case of a refinance) When you do not have the cash to pay the costs up front, or the equity to finance them.
  • If you think you will keep the loan only a year or so. In general, it takes at least two years on most loans to recapture the
  • up-front costs of a two-point loan, and might take six or seven years.
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Fixed-Rate Loans
Plain Vanilla
This is your father's loan. You borrow money, you pay it back, the same payment every month for 30 years (or 15 years, or 40 years) until it's paid off. The rate never changes.
  • Advantage: You will always know what your payment is.
  • Disadvantage: This is typically the most expensive loan.
When it is a good idea:
  • When you know you will stay in the house for a long time.
  • When level payments are important to you for financial planning.
  • If you are insecure about your job future.
  • If you might want to rent the home in the near future but live in the home now.
  • Most Importantly: When interest rates are at a low cycle!
There are two major variations on the fixed-rate loan: Balloon and Buydown.
A balloon is a fixed-rate loan amortized typically over 30 years, but it is due and payable in full, typically in five years or seven years. Some have an extension option at the end of the term, where you may have the option to extend it for the remaining 23 or 25 years, but the rate is reset to current market conditions, there is typically a small cost, and you must have a good payment record.
  • Advantage: Lower cost than a conventional fixed mortgage.
  • Disadvantage: At the end of the balloon period, you must either sell the home, refinance it, or, if the loan is extendible, accept whatever terms the lender happens to offer at that time.
When it is a good idea:
  • If you need a lower rate than a fixed rate will allow in order to qualify.
  • If you intend to own the home less than the term of the balloon and will thus sell it anyway.
  • When fixed rates are rising, this becomes a very attractive option!
A buydown is a fixed-rate loan where you pay extra money up front in points in exchange for a lower rate the first one or two years. Typically the rate is dropped 2% the first year, 1% the second year, and then goes to the full rate. So, if the note rate were 8%, the interest rate the first year would be 6%, the second year 7%, and the third year and every year thereafter, 8%. The up-front points will cost about 2.5% more. Thus, if you would have paid 2 points up front, you would instead pay 4.5.
  • Advantages: Initial lower rate than a fixed-rate mortgage, and although your payments will increase, they will do so by a given, known amount.
  • Disadvantage: Very costly up front.
When it is a good idea:
  • When fixed rates are at a low cycle, but you can not qualify for the note rate.
  • If you are purchasing a home, when the seller is paying for closing costs.
  • If you know your income will rise in the next year or two and can cover the increased payments.
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Variable-Rate Loans (ARMs)
How The Adjustment Works
A variable-rate loan (or adjustable-rate mortgage, ARM) is one in which the interest rate can be adjusted periodically by the bank. The frequency with which it adjusts is called the adjustment period.

Your loan comes with an index and margin. The index is a published interest rate index typically set by market conditions. A well-known example is the prime rate, though it is rare for that to be used for mortgage loans. The most common is the One-Year T-Bill, the interest rate earned on treasury notes issued by the U.S. Government with a maturity date of one year. These securities sell on the open market and the rate can change from moment to moment, though generally it moves in very small increments in the short run. Other indexes commonly used are the Cost-of-Funds Index (COFI), which tends to be the most stable, and the London Interbank Offered Rate (LIBOR), which tends to be the most volatile. The margin is the amount over the index used to set your rate. A typical margin is between 2.5 and 3.0, meaning that your rate is set at the index (using 5.5% as an example) plus your margin (using 2.75% as an example) or 8.25%. Just prior to your adjustment date, the lender will look at the index called for in your contract, add your margin, and send you a letter telling you what your new rate will be.

Important Notes:

  • These loans often start with a "teaser rate," meaning that the start rate is below the fully indexed rate - that indicated by adding your index and margin together. The teaser rate allows you to make lower payments until your first adjustment date. However, if you start with a teaser rate, your loan will almost invariably go up when it adjusts. This is fine, if you anticipate it and can plan for it.
1-Year ARMs
The most common adjustable-rate loan is adjusted annually, though those which adjust every six months are popular, too. These loans typically have an adjustment cap of 2% per year or 1% each six months, meaning the interest rate cannot go up or down more than 2% (or 1%), and a lifetime cap of 6% over the start rate, meaning the rate can never exceed 6% more than the initial rate when you took out the loan. If rates stay where they are when you take this loan out, this loan will always be less expensive than a fixed-rate loan taken at the same time.
  • Advantages: The initial cost and interest rate will be much lower for this loan than it will be for a fixed-rate loan, and the rate may stay lower than your fixed rate would have been indefinitely.
  • Disadvantage: The rate can vary in an unpredictable manner, making planning difficult at best.
When it is a good idea:
  • If you do not intend to keep this loan for very long.
  • If you think your income will improve in the next year or two and want a low start rate for now.
  • If you believe interest rates will stay low for as long as you intend to keep this loan.
Intermediate ARMs
These loans are adjustable, but the first adjustment date is extended, to three, five, seven or even ten years. The longer the "fixed" period, of course, the higher the initial rate. These loans typically will adjust annually after the first adjustment, have a 2% adjustment cap and a 6% lifetime cap, but not always so be sure to ask. In all other respects, they are similar to one-year ARMS.
  • Advantages: Lower rate than fixed-rate loans, but longer fixed period than a one-year ARM to give you some time before they adjust.
  • Disadvantages: At times the cost advantage over fixed-rate loans, particularly when the fixed period is seven or ten years, is so small it is not worth it. The adjustable rate, once it starts, is usually higher than a one-year ARM and almost always more than a monthly ARM.
When it is a good idea:
  • If you have very little down payment and do not wish to get a fixed-rate mortgage. This gives you time before your loan adjusts.
  • If you want to gamble a little, but not heavily, on interest rates not going up.
Monthly Adjustable
These are the loans that can have outrageously low start rates. The interest rate on these loans adjusts every month, although your payment may not. Often, you will be given a payment option with your loan statement: You may pay either the new payment amount to fully amortize your loan over 30 years, or you may continue to pay the old payment, even though it may not exactly amortize the loan. Some of these loans allow negative amortization. This means that you may even be allowed to pay less than the interest charges each month, but the unpaid interest is then added to the loan balance, and the amount you owe goes up! A negative-amortization loan can be great; it gives you the option of retaining a smaller payment without going into default on the loan. It may, however, be difficult to borrow more money in the form of a second mortgage. If you think this loan is for you, please discuss it carefully with your loan counselor.
  • Advantages: These loans typically have lower start rates and lower margins than other adjustables.
  • Disadvantages: You will never have certainty from one month to the next what your payment will be, though they typically do not vary a great deal in one month.
When it is a good idea:
  • If you are very secure in your job, think rates will stay low, and plan on making at least the fully amortized payment each month, this loan may be the best deal for you.
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