Types of Notes and Loans
May 5, 2020
Types of Notes and Loans
Let's discuss three different types of loans borrowers can typically take out, especially when buying a home. The first type of loan is called a conventional loan whereby normally the lender will loan 80% of the total value. We call that a loan to value ratio loan. So, if a borrower buys a property for $100,000 and puts 20% down, which is $20,000, the loan would be $80,000 that is the loan to value ratio loan. On conventional loans, a borrower can put down less than 20% many times. With conventional financing, keep in mind, there is no government intervention involved. This is simply money loaned by a private lender. Another type of loan is called an FHA loan, which stands for the federal housing administration. FHA is really an insurance company run by the government. With FHA loans, the government ensures the local lender in making the loan. The third type of loan is called the Department of Veterans Administration loan or DVA loans. These are loans for veterans who served in the military. In addition, a non-married widow of a veteran can also apply for a DVA loan. With a DVA loan, this is the only type of loan whereby the borrower can purchase a property with no money down. The lender will make a 100% loan to value ratio loan.
Loan Eligibility and PMI
With a DVA loan, the veterans will receive what is called a Certificate of Eligibility, which shows what they are eligible for. As far as the government support is concerned with an FHA loan, FHA again is an insurance company run by the government. Who basically oversees the FHA loans will be HUD (The Department of Housing and Urban Development). If a borrower takes out an FHA loan, the borrower will have to pay the insurance, which is called MIP (mortgage insurance premium). This insurance is paid over the entire life of the loan, as almost all borrowers will finance the MIP insurance into the entire loan. FHA, again insures loans on behalf of the lender. Whereas the Department of Veterans Administration loans, the VA actually guarantees a certain dollar amount to the local lender. So, keep in mind, FHA insures and the VA guarantees as far as the type of property. Veterans can use their eligibility more than once. It is not a once in a lifetime loan that they can obtain. However, the veterans cannot reuse the eligibility until their previous VA loan has been paid off in full. As far as conventional financing is concerned with the down payment, especially if a borrower wants to put less than 20% down, it is a riskier loan to the lender. So, the lender requires PMI insurance on this type of loan as well.
Interest and Payment Plans
Once the borrower has signed the promissory note which creates the debt, then the borrower has to pay off the money that was promised to be paid. There are several ways that the borrower can pay off the money that was borrowed. One type of note is called a straight note or a term loan, these two terms meaning the same thing, where the borrower pays interest only. This is typical on a short-term construction loan that may be only in effect for say six months. Another type of payment plan is called a partially amortized note. Amortized means the payments are going toward both principal and interest, principal being the loan balance or the loan amount. With a partially amortized note, the borrower partially pays down the loan over the term leaving a balance still left over at the end of the loan term.
That balance is then paid off with what is called a balloon payment, which is the final payment, paying off the loan balance in full. A third type of payment plan is called a fully amortized note, fully amortized is what most of us think about with a typical 30-year home loan. Fully amortized means that the payments are applied to principal and interest and the loan is totally paid off over the term, so at the end of the 30 years the borrower owns the home free and clear. Another type of note is called a graduated payment note, although not used too often today. A graduated payment note is where the payments are lower initially with the loan and then they graduate or go up every year. Typically for five years in a row. After five years of payments, they will then level off.
Adjustable Rate Mortgage
An adjustable rate mortgage is a type of payment plan where the interest rate can change typically each year based on certain economic indexes. So, with an adjustable rate mortgage, the interest rates can change, the payments can change, all things can change with an adjustable rate mortgage. One final thing to remember here. If a borrower wants to pay off the loan quicker and not pay as much interest, the borrower many times can make extra payments toward the principal, which will reduce the loan balance quicker and reduce the total number of payments that will have to be made over the term of the loan.
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