Types of loans: fixed, adjustable, junior, seller-carried, and all-inclusive

Classify a loan on separate dimensions

A loan can be fixed-rate, junior, and seller-carried at the same time. Fixed or adjustable describes the interest rate; senior or junior describes lien priority; seller-carried identifies who provides credit; and all-inclusive describes a financing arrangement that wraps an existing debt.

Rate and repayment

A fixed-rate loan keeps its contractual interest rate for its term. A fully amortizing, level-payment fixed-rate loan has scheduled principal-and-interest payments that retire the debt by maturity. Taxes and insurance can change even when that principal-and-interest payment does not. Fixed rate alone does not promise full amortization: a fixed-rate loan can require a balloon payment.

An adjustable-rate mortgage, or ARM, changes its rate at contractual adjustment dates. The index is a reference rate; the margin is the contractual addition. Index plus margin gives the fully indexed rate, subject to applicable caps, floors, and other terms. An introductory rate need not equal the fully indexed rate. A periodic rate cap limits a particular adjustment; a lifetime cap limits the rate over the loan's life. A payment cap limits payment changes, not necessarily interest accrual. If a permitted payment is less than interest due and the unpaid interest is added to principal, negative amortization results.

Priority and seller financing

A junior loan is secured by a lien subordinate to another lien. It is not defined by its size, rate, or lender. Junior lienholders face greater collateral risk because senior claims have priority in distributing foreclosure proceeds. A seller can accept a buyer's promissory note secured by a deed of trust for part of the purchase price. This seller carryback may be senior or junior depending on the financing structure.

Distinguish a carryback note with title conveyed at closing from an installment land contract with title conveyed later. California Civil Code section 2985 defines a real property sales contract as an agreement to convey title upon satisfaction of specified conditions that does not require conveyance within one year of formation, subject to its stated condominium exclusion.

All-inclusive financing

An all-inclusive deed of trust, also called a wraparound, secures a new obligation that includes an existing loan balance plus additional financing. The buyer pays the wrap holder, who uses part of that payment to service the underlying loan. For example, a $300,000 wrap that includes a $200,000 underlying balance represents $100,000 of additional financing, not $300,000 of new money. The wrap does not itself pay off or release the underlying debt.

Review the actual loan documents and applicable restrictions, including due-on-sale provisions, before treating a proposed wrap as permissible. The buyer also faces the risk that the wrap holder receives payment but fails to pay the underlying lender.