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Mortgage Types: Additional types of mortgages

COFI loans

A COFI loan is a type of ARM that is tied to the cost of funds index. Most COFI-based ARMs use the index calculated every month by the Federal Home Loan Bank of San Francisco. According to that Bank, the monthly COFI reflects the actual interest expenses recognized during a given month by all its savings institution members. The COFI tends to be less volatile than Treasury bills, making the interest rate on COFI loans less volatile than the rate on standard ARMs.

Most COFI loans, however, do not have caps, so there is no upper bound on how high your monthly mortgage payment could increase should interest rates go up. In addition, many COFI loans allow "negative amortization," where you can choose to make a minimum payment that is less than the interest accrued for your loan during that time. In this case, your loan balance will actually increase over time.

LIBOR mortgages

A LIBOR mortgage is an ARM that is tied to the LIBOR (London InterBank Offered Rate) interest rate. The LIBOR is a rate of interest at which European banks charge one another for short-term loans, roughly equivalent to the United States Federal Reserve Board's fed funds rate. The rate of a LIBOR ARM is equal to the LIBOR index, plus a margin.

The LIBOR rate, like short-term Treasuries, is relatively stable, but more volatile than COFI-based rates. In times of changing interest rates, the LIBOR rate will react quickly.

Balloon mortgages

A balloon mortgage is a loan where the entire mortgage's principal amount is due at the end of a specified time period. The loan typically has a short term, such as 5 or 7 years, but the monthly payment is computed over 30 years. At the end of the five or seven-year period, you owe the bank all of the remaining principal. This means that if you decide not to sell the property after the loan term is over, you will have to refinance the mortgage.

Balloon mortgages tend to have lower interest rates than standard fixed-rate mortgages, so you will pay less in interest over the course of the loan. If you do not sell by the time the balloon payment is due, however, you will need to pay fees if you decide to refinance. As a consequence, balloon mortgages are best suited for those not planning to stay too long in their house.

Two-step loans

Two-step loans have an interest rate that is fixed for the first period of the loan, then adjusts to either become an ARM, adjusting every year, or a fixed-rate loan. For example, in a 5/25 two-step loan, the interest rate will remain constant for the first five years of the loan, and then change to an ARM or fixed-rate mortgage for the next 25 years, with the interest rate adjusted to reflect prevailing market rates.

Two-step loans also tend to have lower initial interest rates than standard fixed-rate mortgages. They also attempt to provide more rate stability than a traditional ARM.

Related Links
Mortgage Types: Fixed and Adjustable Rate Mortgages
Choosing the Right Loan for You
Mortgage Application Process
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