Straight Term Mortgages
Prior to the Great Depression of the 1930s, the straight term or term mortgage was the common means of financing residential real estate. Under this method of payment, interest only is paid periodically (monthly, quarterly, annually) and the initial amount borrowed, the principal, is not paid until the last day of the loan period. Typically, term mortgages covered short periods of time three to five years and there was normally little intent by either the borrower to repay the principal or the lender to demand payment of the principal.
The original amount borrowed was either extended for another term at an agreed upon interest rate or the borrower would negotiate with a new lender and pay off the old loan. However, as a result of financial conditions during the Depression and the National Housing Act of 1934, which among other things established the Federal Housing Administration, term mortgages became less popular. Borrowers during the Depression were unable to pay the principal when it became due. Because of the tightness in the money supply, lenders were unable to roll these loans over, and thus had to foreclose. Over a million families lost their homes during this time. The failure of the money market led to the creation of the Federal Housing Administration and increased usage of the amortized mortgage. Today, term mortgages are generally used only in the financing of land and construction.
Fully Amortized Mortgages
Unlike the term mortgage where none of the principal is repaid during the life of the mortgage, a fully amortized mortgage requires periodic (typically monthly) payment of both interest and principal. The first part of the payment covers interest on the outstanding debt as of the payment date, and the remainder of the payment reduces the outstanding debt. At the maturity date, the balance has been reduced to zero. The initial payments will consist of more interest than principal reduction; however, the percentage of the periodic payment reducing the subsequent payment is made.
Fully-amortized mortgages are currently the normal means of securing permanent financing. The maturity date is usually much longer than with a term mortgage. For residential property, this type of mortgage usually covers 20 to 40 years and for commercial property the time period is 10 to 15 years.
Partially amortized mortgage also require periodic repayment of principal. However, unlike the fully amortized mortgage, the principal has been only partially reduced. The remaining balance is referred to as a balloon payment.
As a result of higher interest rates and inflation during the early part of this decade, this type of mortgage has become more common in residential financing. Today, some lenders make loans based on, for example, a 30 year amortization schedule but with a five year term. Thus, at the end of five years, the outstanding balance is due.
Besides paying interest and principal each period, a borrower can also be required to pay a certain percentage of annual property taxes and property insurance. For