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Residential Real Estate Loans: Types & Features

Instructor: Ian Lord

Ian is a real estate investor, MBA, former health professions educator, and Air Force veteran.

Different types of residential real estate loans involve varying interest rates and repayment schedules. In this lesson, we will explore some common loans and their features. Take a quiz after the lesson to test your knowledge.

Financing a New Home

After many years of renting an apartment, Ben and Sally found a house they would like to buy. Now they have to make a decision about how to finance their dream home. They discuss residential real estate loans with their lender. The couple carefully consider the features of each loan type before making a decision.

Understanding Amortization

To understand residential real estate loans, Ben and Sally first need a crash course in amortization. Amortization is satisfying a loan by paying back its principal and interest in installments. An amortization schedule is a standard part of mortgage paperwork which lists the amounts for every payment over the life of the loan. For example, mortgage-style amortization features the calculation for the ratio of principal to interest for every loan payment. Early in the mortgage most of the payments will go toward satisfying the interest while the last payment of the loan will be almost entirely principal repayment. However, in straight-line amortization, the principal and interest amounts are constant with every payment.

Fixed Rate, ARM and Hybrid Loans

Fixed rate loans are the simplest of all mortgages. The most common terms are 15 or 30 years but 10-year and 20-year loans are also possible. The mortgage payment is the same every month for the whole term. Interest rates on the loan are locked in, which means the rate stays the same throughout the duration of the loan. Once all payments have been made and the end of the term is reached, the borrower owns the home free and clear.

For those who are not able to afford a fixed rate loan at current interest rates, an ARM might be the answer. In an ARM or adjustable rate mortgage loan, the mortgage interest rate changes during the life of the loan, typically on an annual basis. ARMs offer teaser interest rates to attract borrowers. This rate can rise or fall during the term. The adjustment is based on an index value like the current 1-year Constant Maturity Treasury rate or the London Interbank Offered Rate (LIBOR). Each time the loan adjusts, a new loan amortization schedule is created. This is called re-amortization. Like a fixed rate loan, at the end of the term the borrower gets a clear title.

If an ARM loan is considered too risky to lenders, a hybrid loan might be a better option. Hybrid loans combine the popular elements of both the fixed rate and adjustable rate mortgages. The loan rate remains constant for a set time frame - usually three, five or seven years. During that time the mortgage payment doesn't change. After that the loan becomes similar to an ARM and adjusts each year, along with a new amortization schedule.. Like an ARM, the interest rate is less than an equivalent term fixed rate mortgage.

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