Types of Mortgages and Home Loans
When shopping for a home loan, there are 2 basic types of mortgages to choose from; Fixed Rate Mortgages and Adjustable Rate Mortgages. Each home mortgage type has many different programs and options available.
Fixed Rate Mortgages, or FRM
Fixed rate mortgages are by far the most common type of home mortgage program. The interest rate remains fixed for the life of the loan, therefore the monthly payments for interest and principal will not change over the duration of the loan. Taxes and insurance may increase over time; however your monthly mortgage payment should be very stable.
In the early stages of a fixed rate mortgage, the vast majority of the monthly payment is used for paying interest. As the loan is paid down, more of the monthly payment is applied to principal.
Adjustable Rate Mortgages, or ARM
Adjustable rate mortgages typically begin with an interest rate somewhat lower than a fixed rate mortgage. The thing about an adjustable rate mortgage that scares most people away is the fact that the interest rate changes at specified intervals (for example, every year), depending on market conditions. If interest rates go up, so will your mortgage payment. However, if rates go down, your mortgage payment will drop as well.
Adjustable rate mortgages are usually available in 1, 3, 5, 7, or 10 year loans. An ARM can be a less expensive alternative than a fixed rate mortgage. Along with the lower cost comes uncertainty; how much of an increase will you be able to afford if interest rates go up?
Options and Program variations for fixed rate and adjustable rate mortgages
Interest Only Mortgages
Interest only mortgages are available in both Adjustable Rate mortgages and Fixed Rate mortgages. As the name implies, you only pay the interest on the loan. Because you only pay the interest, the mortgage payments are usually significantly lower than a conventional fixed rate mortgage. The loan offers lower monthly payments, increased cash flow, and maximum tax deductions.
It also offers the home buyer the ability to qualify for larger mortgages as compared to the traditional amortizing mortgage.
Hybrid, two-step, or delayed adjustable Mortgages
These loans typically combine features of a fixed rate mortgage and an adjustable rate mortgage. Some hybrid mortgages may be listed as 5/25, meaning the first five years will be at a fixed rate, and then the remaining 25 years will be at an adjustable rate. Others may be listed as 5-1, meaning the loan is fixed for the first five years, and then resets each year.
The interest on a hybrid loan is usually less than that of a comparable fixed rate mortgage.
Balloon Mortgages
If you are only planning to stay in your home for five to seven years, a balloon loan may be something to consider. With a balloon mortgage, you may borrow for seven years, but the loan is amortized over thirty years. At the end of 7 years, you owe the remaining balance. Which means you'll either need to sell your house, or refinance it.