There are hundreds of different residential loans in the financial markets. As a first-time home buyer, you might get so confused about the complicated financial terminologies. To choose a right type of loan is crucial for your property purchases. Let me introduce you to the most common residential loan types.
OPM.Other people’ money (OPM) refers to the money that does not belong to you, but you borrow from other people. The sources of OPM could include bank loans, government loans, hard-money lenders, small-business loans, and so on. Borrowing money is always risky, but it allows you to double or triple your investment returns. You can also gain controlled of a property with far less equity you have put in.
Interest-only mortgages. With an interest-only mortgage, you pay only interest for a certain number of years, usually 3-5 years, and pay a lump-sum payment at the end of loan life. It sounds like a good deal for people who short of money and purchase houses in a property appreciation environment. However, the interest-only loans are adjustable-rate mortgages (ARMs). Instead of paying a fixed amount of interest with a fixed interest rate, interest-only loan usually has a premium over the market index. If the index rises, the interest rate charged on your loan will rise too.
ARMs.Adjustable-rate mortgage loans (ARMs) are flotation loans. ARMs are tied to an index rises or falls based on government loans. Several indexes are commonly used; they are usually Treasury index, the London interbank Offered Rate (LIBOR), the Cost of Funds Index ( COFI), the Prime Rate, various T-Bills, and the Fed Funds Rate. For example, if the interest rate of your loan tracks the LIBOR, when the LIBOR rises to 5%, you will pay 5% plus the premium you have agreed on the loan contract. ARMs are often easier to qualify for, but the cost of your debt is therefore, higher than the traditional mortgage.
Hybrids.A hybrid loan is a combination of an ARM and a fixed-rate loan. With a hybrid loan, you can pay fixed-rate interest for a certain number of years, after that, you will have to pay floatation interest, i.e. the interest rate is tied to the reference index.
Government secured loans.Even though the government is not usually in the business of lending, government provides the guarantees for the purchases of owner-occupied properties. The FHA ( Federal Housing Authority) is the program that federal government used to promote the American Dream of homeownership. FHA programs are primarily available for the first-time home buyers. However, because FHA programs are government-secured financing, if you can use these programs to purchase the residential properties, you can be more flexible on capital in your other real estate investments.
The bottom line.
There are advantages and drawbacks in different types of loans. There is no one type of loan better than the other, estimate your own financial situation and the goal of your property purchases, find out the best loan type before you rush to a real estate investment.