The two basic types of amortized loans are the fixed rate mortgage (FRM) and adjustable rate mortgage (ARM).
In a fixed rate mortgage, the interest rate, and hence periodic payment, remains fixed for the life (or term) of the loan. The term is usually up to 30 years (15 and 30 being the most common), although longer terms may be offered in certain circumstances. For a fixed rate mortgage, payments for principal and interest should not change over the life of the loan, although ancillary costs (such as property taxes and insurance) can and do change.
In an adjustable rate mortgage, the interest rate is generally fixed for a period of time, after which it will periodically (for example, annually or monthly) adjust up or down to some market index. Common indices in the U.S. include the Prime Rate, the London Interbank Offered Rate (LIBOR), and the Treasury Index ("T-Bill").
At the heart of approving a potential borrower is what lenders call "the three C's of underwriting:"
Credit — your credit history
Collateral — the value of the property securing the loan (your house)
Capacity — your financial ability to assume and repay debt
Taken together, these create a portrait of a potential borrower's risk - that is, whether or not he or she will pay back his or her loan. If the risk seems high, the lender will be reluctant to make the loan. Depending on the degree of risk, a lender may choose to charge higher rates and/or fees, or decline to make the loan altogether.
The loan to value ratio (or LTV) is the size of the loan against the value of the property. The loan to value ratio is considered an important indicator of the riskiness of a
mortgage loan: the higher the LTV, the higher the risk that the value of the property (in case of foreclosure) will be insufficient to cover the remaining principal of the loan.
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