Time Stamps:
1:08 – “There’s so many different types of mortgages out there. What do I need to know?”
3:27 – “What is a 5:1 mortgage?”
4:05 – “3 Types of Government Mortgages”
5:50 – “What is a jumbo loan and a conforming loan?”
8:07 – “What is a non-conforming loan?”
8:45 – “Different types of mortgage payments”
Mullooly Asset Show: Episode 53 – Types of Mortgages – Transcript
Tom Mullooly: In episode 53, we delve into the wild, wild world of mortgages.
Welcome to the Mullooly Assets Show. I’m your host, Tom Mullooly, and this is episode number 53. These questions, where do we get them from? They come from our viewers and they come from our clients. If you’ve got a question that you need to talk to someone about, you need to talk to a financial planner, an investment advisor, get in touch with us. You can hit that red subscribe button if you’re watching on YouTube or just send us an email through the website. We’d be happy to answer your questions.
Tim, what are we going to be talking about today?
Tim: There’s so many different types of mortgages out there. What do I need to know?”
Tom Mullooly: What do you need to know regarding mortgages? There’s a lot. Before we even get into mortgages, I think it’s important to know the difference between secured loans and unsecured loans. We seem to be having this conversation a lot with folks who are talking about cash flow and debt management. Understand that a secured loan is a loan where you’ve borrowed money against an asset, like a car. That’s a secured loan or a home, a mortgage. That’s a secured loan. You know if you don’t make your payments on your car, guess what happens to your car overnight. Disappeared. You wake up in the morning and it’s not in the driveway anymore. There’s the risk with a secured loan. If you don’t make the payments, they can repossess or they can foreclose and kick you out of your house. It’s kind of a risk.
What’s an unsecured loan? Something that is not backed by an asset. A credit card loan is an unsecured loan. You want to know why you pay 19% interest on your credit card? It’s an unsecured loan. The bank is taking a risk that you’re going to make those payments every month, but let’s talk about mortgages.
It’s important to know the types of mortgages. In the most basic terms, there’s fixed and there’s variable mortgage payments. Fixed payment, super simple, once you’re approved for a mortgage, they’re going to tell you that your payment is this, it’s due on this date, every month. If it’s a 30-year loan for the next 360 months, you make the payments, that baby’s yours. What’s the only thing that can change in a fixed mortgage? If your property taxes go up, you’re going to get a letter from the mortgage company and they’re going to tell you, “Hey, your payment’s going up, and it’s not our fault. The interest rate doesn’t change with your loan. It’s the property taxes in your town. Sorry.”
An adjustable rate mortgage usually will have some kind of fixed period of time, and then it resets or adjusts on a continual basis. A very popular type of adjustable rate mortgage is what these realtors, these agents, they call it a, “Oh, you can get a 5/1 mortgage.” What does that mean? 5/1 mortgage means that your rate is fixed for the first five years, and after that, it adjusts once a year every year for the life of the loan. It’s a 30-year loan. Just know that your rate’s going to be fixed for the first five. After that, kind of taking a risk to see what’s going on.
We get a lot of questions about, should we do a government mortgage or a conventional mortgage? A lot of people don’t even understand what that’s all about. I just want to spend a minute talking about this. With government mortgages, understand that there’s three basic types.
US Department of Agriculture does write mortgages if you live in a rural area, but the two other types of mortgages, government programs, that are more widely known are FHA, which is basically a mortgage insurance program. It’s underwritten by the Housing & Urban Development Program. If you’ve paid PMI, private mortgage insurance, you know what you’re dealing with here. Basically, FHA loans allow you to make a really small down payment. You have very little equity in the property, but you have to pay mortgage insurance until you get to a certain level of equity in it, so it adds to your mortgage payment. A VA loan, Veterans Administration loan, if you have been honorably discharged from the Armed Forces, you are probably going to qualify for a VA loan, which is a really nice deal because you can get 100% financing, no down payment, for a VA loan, and VA loans are really popular because even if the mortgagee, the homeowner, defaults on their payment, the loan is guaranteed, so pretty good deal.
What’s a conventional mortgage? Conventional mortgage is just an agreement, a mortgage, a loan, between a lender and someone who’s looking to purchase a home. Then we get into, we delve in a little deeper, and people ask, “Well, what’s the difference between a conforming loan and a jumbo loan?” A jumbo loan, in most areas of the United States is anything that’s $417,000 or more. That’s the size of the loan, not the price of the house. A jumbo loan, anything 417,000 and up. In major metropolitan areas, that cap has been raised to $625,000 for jumbo loans.
If those are jumbo, what’s a conforming loan? Conforming loan is something below those numbers. It only means … Conforming loans mean … The meaning behind that is they conform, they meet the guidelines, the underwriting guidelines, put together by Fannie Mae and Freddie Mac, and Freddie Mac is the federal home loan mortgage company. I don’t know why they came up with a goofy name like Freddie Mac. They could have just called it the Federal Home Loan Mortgage Company, but Fannie and Freddie, that’s really what happens. What happens is if you’ve got a conforming loan, your bank or your lender, if it conforms, is going to push this through to Fannie Mae and Freddie Mac.
What happens then? Fannie and Freddie actually will take the loan, and the money that the bank lent goes back to the bank so they can make more loans, and Fannie and Freddie basically guarantee the timely payments of interest and then they repackage them as a mortgage-back security, and they sell them, and if you own a government bond fund, take a look in there. You’re going to see a big percentage of the assets in your mutual fund, your government bond fund, mortgage-back securities. The great thing about Fannie and Freddie is that by passing the mortgages through these companies, it gets money back to the local banks and lenders so that they can make more loans. It really is a good deal, and, occasionally, we’re going to get a 2008 where, remember, the only business between Fannie and Freddie is personal home loans, so when that business falls apart, there’s going to be problems.
If those are conforming loans, what are nonconforming loans? Pretty much everything else. You’ve got jumbo loans. You’ve got subprime loans are included in there. This is really where these mortgage problems from 10 years ago really began.
Before we get too long with this video, I want to just spend a moment talking about the types of payments. Everybody knows that if you own a mortgage, you’re going to make a monthly payment, and if you have a 30-year loan, you’re going to make 360 monthly payments, and then you own the whole thing, but there’s other ways that you can pay for your mortgage. Some lenders have these arrangements where you can set up a bi-weekly or a bi-monthly type of mortgage where you’re making, with a bi-monthly, you’re making two payments a month. Instead of 12, now you’re making 24 payments. A bi-weekly is every other week, so you’re actually making 26 payments of a smaller amount, but your principal gets paid down a little faster, so you’re actually shortening the life of your loan, and the interest that you’re going to be paying. If you can swing it, it’s a great thing to do.
There’s also graduated payments where the payments start out small and get bigger over time. That can lead to problems if your income doesn’t do the same thing. We also have interest only mortgages where you pay interest only on the loan, usually for a period of five years, sometimes longer, and then it converts to a traditional mortgage after that. You have balloon mortgages. You have these really low payments and then, at some point down the road, five years from now, 10 years from now, the whole thing comes due. That usually makes people run out and refinance. That’s tricky because you have to make a bet on, one, your home’s going to appreciate and, two, what interest rates are going to be like. You’re really rolling the dice with balloon mortgages, but sometimes it’s the only way you can get into a home.
Then there’s reverse mortgages. Tim, we should probably do a separate video just on reverse mortgages now. They’ve really changed quite a bit in the last four years. They’re now called home equity conversion mortgages. They want to get rid of that stigma that it’s the lender of last resort. They really do have some benefits. You have to be 62 to be eligible for a reverse mortgage, but that’s something that’s worth looking into, and we should probably make another video about that.
With other financial planning topics that we talk about, and we’ll cover this in another video, we talk about the benefits of renting versus buying. It’s really coming down to a question of what tax bracket are you in and what your cash flow situation is like. We also deal with clients, and if you’re working with a financial planner, make sure that you ask them about refinancing. I talk about second mortgages and talk about home equity lines of credit.
A ton of things to cover in episode 53. Hopefully, we didn’t go too fast. If we did, hit the pause button so you can catch every note. Thanks for watching, and we will see on episode 54.