Least understood loans may be best mortgage options

For years, potential home buyers viewed 15- or 30-year fixed rate loans as the be-all, end-all of the home mortgage spectrum.

Not anymore.

According to a mortgage executive in Washington, D.C., imaginative new loan options albeit sometimes not well understood have emerged as viable solutions for homebuyers. The new loans are evidence there is life loan life, that is beyond conventional mortgages.

"When our parents bought houses, they got a 15- or 30-year fixed rate loan," says Deb Levy of Bank of America. "That conventional wisdom was passed along to their kids. Young clients immediately tell me 'fixed rate, fixed rate' because that's what they've been told."

Fixed rate loans are easiest to grasp because the terms are cut-and-dried: a set term at a set rate. But with people tending to move more frequently and real estate prices escalating rapidly, many buyers feel locked down when they lock in long term loans even though relatively few live in a home long enough to completely pay a 15- or 30-year note.

These days, Levy is more likely to discuss hybrid, interest-only and combination loans with potential customers. The trio is some form of adjustable rate mortgage or at least offer an adjustable rate option.

A hybrid loan is part fixed rate and part adjustable rate loan. The first one-three-five or seven years is at a fixed rate. Thereafter, the loan converts to an adjustable rate.

The upside to hybrids is lower initial interest rates and monthly payments below a comparable fixed rate loan. Comparison tables at bankofamerica.com show a hybrid loan rate on a $100,000 mortgage can be one-quarter of a percent to as much as 2 percent lower. This translates to a monthly savings of more than $100. Levy rates these loans as ideal for homeowners who want to more home for lower monthly payments or those "betting they won't be in the house long enough" before the adjustable rate term kicks in.

The down side is uncertainty for homeowners. Rates during the adjustable term can fluctuate above fixed rates, thereby raising monthly payments. But rates could dip lower, too. There is a safety net of sorts; even if rates spike, adjustable rates are capped at the time the loan is made.

According to Bank of America's Levy, the "hot buzz product" in today's mortgage markets are interest-only loans.

The loans are as advertised; homeowners pay only the interest rate owed. For example, if principal and interest on a $100,000 loan amount to $583 per month, the borrower pays only the interest portion -- $479 -- each month. The borrower must eventually pay off the principal but as with the hybrid loans, the homeowner is money ahead if they live in the home for a relatively short period.

So when is the principal paid back? Levy says interest-only loans are designed for borrowers with variable income streams -- such as those who earn hefty quarterly bonuses -- who can pay down chunks of principal when money is available. Inheritances or other financial windfalls can also be used to pay off principal amounts.

If you use an interest-only loan, you won't build equity in the home beyond the increase in market value of the home itself. A portion of your equity is earned as you pay off the principal amount.

Homebuyers looking for a low down payment and a way to avoid costly private mortgage insurance should check out combination loans. Until these loans came into being, borrowers needed to plunk down 20 percent to avoid PMI. Now, applicants with good credit can put down lesser amounts to avoid PMI.

These two-in-one loans blend a first mortgage and a home equity loan or line of credit. The mortgage portion can be at fixed or adjustable rates. The home equity portion typically acts as a second mortgage, and is at a somewhat higher rate. In the past lenders permitted home equity loans only after the client owned the home. Borrowers can avoid some fees and closing costs because of the dual nature of the combined loans.

These loans are often term "80-10-10" loans a loan for 80 percent of the property value, 10 percent down payment and the remaining 10 percent as the home equity portion. These loans are also available in 80-15-5 and 80-20 increments.

Levy says the new loans are an effort by lenders to be more creative at a time when financial needs and lifestyles require different approaches to home finance. "It's all about how we as lenders can meet the demands of consumers," says Levy. "People are looking to get into homes, and these loans are one way to do that."

(Consumers can visit the Bank of America loan learning center at bankofamerica.com. Key words: learning center.)