Types of Mortgages
Most buyers are going to need some type of financing to purchase their new home. Understanding the different types of mortgages out there can help you figure out just which one will work best for your situation. Here are the different mortgage types, how they work, and how to choose the right one.
The fixed-rate mortgage is the most standard type of mortgage for those who intend to stay in their homes. The benefit of this type of mortgage is that the monthly payments do not change. The downside is that neither the interest rate nor monthly payment amount ever goes down. Whatever the interest rate is at the time that your loan starts is the rate that you will have over the life of the loan.
These types of loans are most attractive when interest rates are low so that buyers can lock in that interest rate. As with all home loans, your particular situation will dictate which loan is best for you. Here is how each type of fixed-rate mortgage stacks up against the other:
15-Year Fixed Rate Mortgage: Monthly payments are the highest for 15-year mortgages; however, equity builds faster too. The loan is paid off in half the time of other FRMs. This is the type of loan for buyers who want the stability of a regular monthly payment but want to pay the loan off quicker.
20-Year Fixed Rate Mortgage: As you might suspect, the 20-year loan is the middle ground between the other two FRMs. The loan is paid off quicker than a 30-year loan. That means that the amount of interest paid over the life of the loan is significantly less than for a 30-year mortgage.
30-Year Fixed Rate Mortgage: Most buyers who choose fixed-rate mortgages go for the 30-year loan. It’s the most stable FRM, with lower monthly payments than either a 15 year or 20 year mortgage. It is easier to qualify for a 30-year mortgage and you can claim a bigger tax deduction each year. This loan is for people who plan to live in the same place for a long time.
Adjustable-Rate Mortgages (ARMs)
Just as the name implies, the rates on adjustable rate mortgages change. The introductory rate for an adjustable-rate mortgage or ARM is usually lower than a fixed-rate mortgage. However, over time, the rate fluctuates with interest rates. That means that even if you get in at a low rate, you could end up paying a really high monthly mortgage payment when interest rates go up. The bank that supplies your loan calculates your interest rates based on a particular index.
It is very important to understand the formula your lender will use and to get it in writing when choosing an ARM. Lenders are capped at a certain amount of interest that they can charge you. Still, when rates go to their highest level, will you be able to afford the monthly payment? That is a very important question to figure out the answer to before you take out an ARM.
These types of mortgages are best if you do not plan to stay in your house for long and can cover any increase in interest rates.
Convertible Adjustable-Rate Mortgages
Convertible ARMs offer a low introductory rate and convert to a fixed-rate mortgage after a specified number of years. When interest rates are low, this can be a very affordable option. However, be aware that when the loan converts, your fixed rate will be set at the future interest rate, not at the lower introductory rate.
Finally there are two main government loans that homebuyers can take advantage of. They offer easy qualification, low fixed interest rates, and affordable monthly payments. However only certain people will qualify:
FHA Loans: Made for low-income Americans. Qualifications for this loan are based on income.
VA Loans: Service members, veterans and their spouses are eligible for VA loans. The qualifications differ depending on the branch of service and length of time in the service. VA loans are capped based on a calculation of average home prices from state to state.