What are the different types of mortgages?

After a week of straight rain, I am excited for some sun this weekend. I don’t plan to do anything different… but at least it’ll be bright in my house.

Whether you have a mortgage or not, you have surely heard many of the acronyms and types of mortgages. Through all the confusion, you can effectively group all the nonsense into two categories: how the interest behaves and who is securing the loan. 

How the interest behaves

1. Fixed Rate

   • This is your typical mortgage. You lock in an interest rate and it doesn’t change for the entire duration of your loan. Your principal and interest payment will not go up. Your insurance and taxes will though…

2. Adjustable Rate Mortgage (ARM)

   • With an ARM, your interest rate will change annually after a fixed period. The fixed period is typically 5, 7, or 10 years. Then, your interest will change annually for the rest of the 15 or 30 year mortgage. 

   • The fixed period is usually expressed like “5/1 ARM.” Meaning a 5 year fixed period with annual (hence the 1) adjustments. 

   • ARMs usually start with a lower interest rate for the fixed period but can rapidly increase during the adjusted period. 

3. Interest Only Mortgage 

   • With interest only, you pay only interest for the first 5, 7, or 10 years. Then, you pay all the principal over the remaining years. This drastically lowers the payments at the start but spikes them following the initial period.

   • These mortgages are advantageous for investors/flippers who plan to hold the house for a short period and increase the value through improvements. Rather than waiting 45 years for the home value to triple, they will improve the value through renovations. They can sell the house for more than they bought, pay off the loan, and keep the profit. 

   • Following the 2008 crash, interest only mortgages are far less common. They make up only 3% of all new mortgages (according to Mr. GPT).

Who secures the loan 

1. Conventional 

   • A conventional loan is backed by the bank loaning you money. If you default, the bank is on the hook for any losses. This is why you typically have to put 20% down. 

   • With a 20% down payment, the bank can be fairly confident they will recover all of their loaned money if you default. The 2008 housing market crash is the only time in the past century the market has lost over 20% nationally. So, if you default and the bank has to take over your home, they will likely sell it for at least 80% of your loan value.

   • If you don’t put 20% down, you have to pay Private Mortgage Insurance (PMI) until you’ve paid 20% of your principal. The bank can’t sleep without it. 

   • PMI can be very expensive at 0.5 - 1.5% of your original loan value per year.

2. Federal Housing Administration (FHA)

   • An FHA loan is backed by the FHA. A bank still loans you the money, but if you default, the bank gets to ask the FHA to pay them back for any losses they took on your mortgage. 

   • Because of the security of the government, an FHA loan has lower credit and down payment requirements.

   • FHA loans do require Mortgage Insurance Premium (MIP) which can be paid upfront (financed into the loan) or monthly. MIP is basically PMI but rebranded. 

3. VA (Department of Veterans Affairs)

   • A VA loan is for service members and veterans that requires no down payment or PMI/MIP.

   • VA loans started following WWII to support returning soldiers' reintegration into civilian life. 

4. U.S. Department of Agriculture (USDA)

   • USDA backed loans are aimed at supporting rural families and farmers. 

   • They also require a form of insurance called an Upfront or Annual Guarantee Fee. It operates the same as MIP or PMI, just rebranded and a little cheaper. 

   • USDA loans do offer a rarely used USDA Direct loan which is provided directly by the US government. Unlike every other loan that banks fund, a USDA Direct loan comes from the US Government and is aimed specifically at rural low and very-low income families with no other financing options. 

I hope the multiple ways the government protects banks who loan money for homes illuminates that homeownership is just a government PSYOP to get you to cut your grass. Homes are just overpriced sheds for lawn equipment. 

You can mix and match these loans. You could get a fixed rate VA loan or an ARM FHA loan.

Boom. Just like that, you are now ready for your next cocktail party. You can throw some acronyms at your new friend and test their knowledge. You're welcome.

Debrief on Deck

Next week, we will talk about the Invest America Act. Senator Cruz proposed giving each newborn baby $1,000 in an investment account. Honestly, I love the idea. I am a realistic person though and realize it will never happen. So let’s talk about how you can do it without the government’s help!

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on Instagram.

Until then, stay the course.

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