Understanding Mortgage Loan Lingo

The following sections explain commonly used loan terms.

Long-term or short-term mortgages

The basic definition of a long-term mortgage is any loan that's amortized over 30 or more years. A loan that must be repaid in less than 30 years is known as the short-term mortgage.

These standards date back to the late 1970s when people could obtain any kind of mortgage they wanted, as long as it was a fixed-rate, 30 year loan. Choices for a short-term mortgage were nearly as limited. People looking to buy a home could either get a balloon loan with, for example, a 30 year amortization schedule and a 15 year due date, or an FRM with either a 10 or 15 year term. With the balloon loan, home buyers would make the same monthly principal and interest payments for 15 years and then get nailed with a huge balloon payment to pay off the entire remaining loan balance.

Short-term mortgages have a lower total interest charge than the total interest paid for a long-term loan (of the same amount) at the same interest rate. It is important to note, however, that short-term mortgages usually have lower interest rates than comparable long-term loans.

Note, even though short-term mortgages have lower interest rates than long-term loans, qualifying for a short-term loan is often more difficult due to its higher monthly loan payments. Lenders generally don't want people spending more than 28% of their gross monthly income on mortgage payments.

Primary or secondary mortgage market

The primary mortgage market is when lenders make loans directly to people. Lenders sell most of their mortgages as soon as they have been signed for by the borrower. These loans are purchased by insurance companies, pension funds and other private investors in the secondary mortgage market. Mortgage lenders sell the mortgages they originate so that they can have more funds to lend and, of course, so that they can make a profit.

The U.S. government is an extremely important force in the secondary mortgage market through two federally chartered government organizations namely, the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal National Mortgage Association (FNMA). FNMA and FHLMC’s main goal is to stimulate home purchases and residential housing construction by pumping money into the secondary mortgage market.

Government or conventional loans

About ¹/₅ of all home loans is either insured or guaranteed by an agency of the federal US government. These mortgages are known as government loans. The rest of the residential mortgages originated in the United States are referred to as conventional loans.

Below is a brief explanation of the different government loans available:

• Department of Veterans Affairs (VA). In 1944 Congress passed the Serviceman's Readjustment Act, commonly known as the GI Bill of Rights. One of its provisions enables the VA to help eligible veterans and people on active duty buy primary residences. The VA does not have any money of its own and so guarantees loans granted by conventional lending institutions that participate in VA mortgage programs.

• Farmers Home Administration (FmHA). As with the VA, the FmHA isn't a direct lender. Contrary to its name, you don't have to be a farmer to get an FmHA loan. But you do have to buy a home in a rural area, and not a city. The FmHA insures mortgages granted by participating lenders to qualified buyers who live in rural areas.

• Federal Housing Administration (FHA). The FHA was established in 1934 to stimulate the U.S. housing market. It helps people with low to medium incomes obtain mortgages by issuing federal insurance against losses to lenders who make FHA loans. As with the VA and FmHA, the FHA does not loan the money directly. Borrowers must find an FHA approved lender such as an S & L, bank, or other conventional lending institution willing to grant a mortgage that the FHA then insures. It is important to note, that not all commercial lenders choose to participate in FHA loan programs.

Conforming or jumbo loans

Conforming loans are conventional mortgages that fall within FNMA and FHLMC's loan limits. Jumbo or nonconforming loans are mortgages that exceed the maximum permissible loan amounts.

However, it is important to note that nonconformity will cost you. Lenders can cut their risk by reducing the loan-to-value ratio. However, conventional lenders will generally request more than the usual 20% down payment on jumbo loans over $500,000. You will probably be required to put down a cash payment of (at least) 25%. Interest rates on nonconforming fixed rate mortgages generally run from ³/₈ to ¹/₂ a percentage point higher than conforming FRMs.