Last week, I began describing the many types of real estate loans available for residential, commercial, industrial, or agricultural property. Thinking about buying property? There’s a loan for just about every situation—some for expensive properties, some for fixer-uppers, some for farmers, some for businesspeople, some for short terms, some for long terms. You name it, it’s out there.
Insurance Companies – These are very large loans, for principal amounts greater than $3 million (think big office buildings or apartment complexes). The rates can be very competitive, but to get approved, your project must be of very high quality. Also, beware of the nasty pre-payment penalties.
Interest Only – These are usually private party loans, though they can be done through a bank. They have low monthly payments and are usually short-term, in the five-year range. If they are long-term loans, they usually begin as interest only and later convert to a fully amortized loan or a balloon payment—a payment that is more than double the regular monthly payment. Short-term loans have a more competitive interest rate than long-term loans. The longer the term, the higher the risk for the lender. Today the prime rate is about 5.25 percent; in five years it could be 10 percent.
Fully Amortized – When we think of real estate loans, most of us picture a fully amortized loan. All this means is that the regular monthly payments eventually pay off the loan in its entirety at the end of the term without the need for a balloon payment. Many different types of loans can be fully amortized.
Variable Rate – Also called an adjustable rate mortgage (ARM), this simply means that the interest rate isn’t fixed. Usually, ARMs start with lower interest rates than conventional loans because the borrower is taking on the risk of future interest rate changes. If rates jump, so does the mortgage payment. On the bright side, if rates drop, mortgage payments go down, too.
These loans require an index and a margin. The index is an independent, verifiable interest rate like the published prime rate or Treasury bill rate. The margin is the percentage added to the index to determine the loan’s interest rate. For example, if the index is 3 percent and the margin is 2 percent, then the loan’s interest rate is 5 percent.
Teaser Rate – These are a type of variable rate loan to be wary of. The initial interest rate is usually far below conventional rates, but usually within months, the rate increases to a fully indexed rate, which comes with a commensurate increase in your monthly payment. The only reason these exist is to allow people to qualify for loans that will eventually require much higher payments. They’re okay when you know you can afford the higher payments, but are unable to prove it at the outset of the loan.
Negative Amortization – All negative amortization loans are teaser loans, but not all teaser loans are negative amortization loans. Let me explain. Negative amortization means starting monthly payments at less than the interest for that given month. Interest might total $1,000, but your payment is only $800. The next month, the balance on the loan is $200 higher. This only lasts for a short time. At that end of that introductory period (could be a few months or even up to a year), the monthly payment goes up and continues to rise until the payment is high enough to cover all the interest and enough principal to repay the loan during the term of the loan, usually 30 years.
United States Department of Agriculture (USDA) – These are intended for low-income borrowers and are limited by a maximum income standard. They include a very low down payment, a 30-year term and fixed interest rate that’s usually a little higher than conventional rates.
Check back next week and I’ll share information on even more types of real estate loans.
If you have questions about real estate or property management, please contact me at rselzer@selzerrealty.com or call (707) 462-4000. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 40 years.