Introduction

Lenders offer a variety of mortgage products tailored to the needs of the borrower and the conditions prevailing in the secondary markets. The myriad of products may seem confusing and perhaps frustrating. However, despite the differences, it is important to realize that all products represent an extension of credit to a qualifying borrower against a pledge to return the principal with interest and where the pledge is collateralized by real estate. The difference among the loan products is due to the various features and options that they offer. These features and options can be referred to as Loan Characteristics. The key for the borrower is finding a mortgage loan product whose features would meet his/her individual needs. For the lender it is important that the loan products can easily be absorbed and traded in the secondary or capital markets.

Types of Loan Products

Loan products have been classified in different ways based on various characteristics. Below is a description of different loan categories.

Based on Changes in Interest Rate (Finance Method)

1. Fixed Rate Mortgage (FRM): A mortgage loan in which the interest rate remains fixed throughout the life of the loan. A Fixed Rate Mortgage offers the borrower the benefit of fixed monthly payments with no exposure to any change in interest rates in the market. The lender, on other hand, carries the interest rate risk. Fixed Rate Mortgages are the most common form of mortgage loans.
2. Adjustable Rate Mortgage (ARM): A mortgage loan in which the interest rate adjusts periodically based upon the movements of a pre-determined index or reference rate. This allows the lender to ensure a stable return even when the interest rate in the market changes. However, the borrower is faced with periodically changing monthly payments. ARM loan is also known as Variable Rate Mortgage (VRM).
3. Hybrid ARM: Hybrid ARM, which stands for Hybrid Adjustable Rate Mortgage, is a mortgage loan that has interest rate fixed for an initial term followed by adjustable interest rate for the remainder of the life of the loan. Lenders may offer loans with an initial term as short as 6 months to as long as 10 years. Due to their similarities to an ARM, many lenders do not differentiate between ARM and Hybrid ARM.
4. Home Equity Line of Credit (HELOC): Home Equity Line of Credit is an open-ended adjustable rate mortgage loan that is secured by real estate and is subject to a maximum draw amount (facility limit) and a fixed term. A borrower may choose to withdraw the entire line of credit or a smaller amount. The lender may allow withdrawal of funs using a credit card or checks. Interest is charged to the borrower for the amount actually withdrawn. HELOC’s are generally adjustable rate loan with monthly interest rate adjustments indexed to the Prime Rate.
5. Home Equity Loan (HELOAN): A HELOAN is a fixed interest rate mortgage loan that is secured by the borrower’s equity in the property. Generally, a HELOAN is a second lien mortgage.

Based on Loan Amounts

1. Conforming Loan: A mortgage loan that can be purchased or guaranteed by Fannie Mae or Freddie Mac and which restricts the maximum loan amount to the conforming loan limits by Federal Housing Finance Agency (FHFA).
2. Non-Conforming Loan: A mortgage loan that does not conform to the conforming loan limits set by FHFA or the underwriting guidelines established by Fannie Mae or Freddie Mac. Fannie Mae or Freddie Mac would not buy these loans. Therefore, these loans have lower liquidity and carry higher interest rates and origination points. Jumbo Loans are a type of non-conforming loans which exceed the conforming loan limits set by FHFA.

Based on Amortization Options

1. Fully Amortized Loan: A Fully Amortized Loan is designed to pay off the principal and interest during the life of the loan through periodic monthly payments. At the end of the loan term there is no balance due. Fully amortizing loans are the most common form of mortgage loans.
2. Balloon Mortgage Loan: A mortgage loan where the amortization period is longer than the loan term due to which the monthly payments will not cover the entire principal and interest and results in a lump-sum amount to be due at the end of the loan term. The lump-sum amount due at the end of the Balloon mortgage is known as Balloon Payment.
3. Interest Only Loan: A mortgage loan that requires the borrower to make monthly payments that cover only the interest on the loan, with the principal amount remaining constant. No amortization takes place because the principal repayment is not included in the monthly payments. Generally, interest only portion is only for a short period and the loan subsequently converts to a fully amortized loan. Upon conversion the monthly payment would increase.
4. Negative Amortization Loan: A mortgage loan that allows the borrower to make periodic payments that are less than the interest accrued in that period, which causes the principal amount to increase over time. This is because the difference between accrued interest and periodic payment is added to the loan amount as principal. This causes the owner’s equity to reduce since unpaid loan amount increases dramatically over a period of time. Negative Amortization loans are also called NegAm loans.
5. Pay Option ARM: Pay Option ARM is an adjustable rate mortgage where the borrower has different options in making periodic payment ranging from fully amortized amount, interest only amount, or an amount that is less than the interest only amount. Pay Option ARM loans are the most common example of loans having a negative amortization feature.
6. Reverse Mortgage: Reverse Mortgage Loan is a negative amortization loan that is designed to allow the borrower to utilize the equity in the home and convert into cash flows which can be in the form of fixed monthly payment, a lump-sum amount, or a line of credit. No repayment is due and the loan is paid upon occurrence of specific events (death, sale of property, etc.). As per regulations in effect in the US, these loans can be offered only to senior citizens who are 62 years or older.

Based on Institution that is Offering or Guaranteeing Loans

1. Government Loan: A mortgage loan that is guaranteed or insured by an agency of the federal or state government such as VA, FHA, RHS, or others. Government loans are issued by private lenders and not by the government agency itself. The government protection against borrower’s default allows the lender to offer loans to the borrower at a lower interest rate. The most common government loans are:
   1. FHA Loans: Loans that are insured by Federal Housing Administration (FHA).
   2. VA Loans: Loans that are guaranteed by the Department of Veterans Affairs (VA).
   3. RHS Loans: Loans that are guaranteed by Rural Housing Service.
2. Conventional Loan: A mortgage loan that is based on guidelines set by private investors and is not guaranteed or insured by an agency of the federal or state government. Conventional loan programs follow pricing of the secondary market for loan products. These loans may be purchased and securitized by Government Sponsored Entities ("GSE") such as Fannie Mae and Freddie Mac.

Based on Credit Quality (Borrower's Default Risk)

1. Prime Loan/A-Paper Loan: A mortgage loan offered to the most creditworthy borrowers and usually has strict underwriting guidelines. The high creditworthiness of the borrower is demonstrated by high credit score, stable income, stable employment, and other risk mitigating factors. These loans generally do not allow 100% financing and are within the conforming loan limits. The strict underwriting guidelines require the borrowers to verify their assets, income, and employment. Prime Loan is also known as A-Paper Loan.
2. Alt-A Loan: A mortgage loan that carry more default risk than an A Paper loan and is targeted at borrowers having less than perfect credit. The credit score of borrowers usually range between 620 and 720. Other features of the loan that increase the risk are 100% financing, non-owner occupied properties, limited or no verification of income, assets, or employment. Alt A Loan is short for Alternative to A-Paper Loan.
3. Subprime Loan: A mortgage loan that is offered to borrowers with significant default risk. Subprime loans are offered to borrowers that have a higher risk of non-repayment due to low credit scores or a history of late payments and defaults. Such borrowers may have experienced bankruptcy, foreclosure, collections, late payments, and similar financial distress. Subprime loans carry a higher interest rate and fees to compensate for the higher risk of default.
4. Non-Prime Loan: Non-Prime Loan is a loan that is not a prime loan and includes subprime loan and Alt-A loan. These loans are offered to borrowers that do not qualify for the Prime loans and have some weakness in their creditworthiness.

Based on Type of Real Estate (Collateral Type)

1. Residential Real Estate Loan: A mortgage loan that is secured by residential real estate such as a single family residence, multi family residence, condominiums, or any other building occupied and designed for residential purposes.
2. Commercial Real Estate Loan: A mortgage loan that is secured by commercial real estate such as office complex, industrial estate, shopping center, or any building occupied by a business.
3. Lot Loan: A mortgage loan that is secured by vacant land. This loan is targeted for borrowers who are not yet ready to begin construction on the vacant land.
4. Construction Loan: A mortgage loan that is extended to borrowers that seek to construct a building on a vacant land and is secured by vacant land and proposed improvements on the property. Construction loans are usually taken when a borrower plans to build property on a vacant land or plans to demolish and rebuild the property. These loans are short term in nature and the funds are released in stages based on the percentage of completion of the property. When the property is constructed, the loans are usually refinanced into a permanent loan.

Other Loan Types

1. Hard Money Loan: A mortgage loan that is offered by private investors or non-banking organizations and which is primarily underwritten against the property. Hard Money Loan may include loans from individual investors, investment clubs, private equity firms, and similar entities. However, in a number of places hard money loan is used interchangeably with private money loan.
2. Private Money Loan: A mortgage loan that is offered by private investors or non-banking organizations and which is extended based on the personal relationship with the borrower. Private Money Loan may include loans from friends and family, individual investors, employers, and similar entities. The key feature is that the lender is extending credit based on the personal relationship. The lender may still consider the credit and collateral, but the character of the borrower takes highest priority. However, in a number of places private money loan is used interchangeably with hard money loan.
3. Bridge Loan: A mortgage loan is a short term loan with the expectation that the borrower will obtain permanent financing. The loan is usually repaid in a single lump-sum. Bridge loans usually carry high interest rate. These loans are also known as Swing Loans.

Updated: May 22, 2013