What Kind of Mortgage Fits You Best?
There are a number of different types of loans available to people wishing to purchase a home. The type of loan that suits an individual borrower varies depending on their personal financial situation, and their objectives for home ownership. Following is a summary of the most common types of loans used to finance residential property.
Purchase Loans are mortgages used to finance the purchase of a home. Whether you are buying a single family home, townhouse or condo, if you are not paying cash, you'll need a purchase mortgage.
Refinance Loans are used to replace the current financing for a residential property. Borrowers frequently consider refinancing a loan to reduce their mortgage rate, change the type of financing (such as moving from an Adjustable Rate Mortgage to a Fixed Rate loan) or to reduce the length or term of their loan.
If you are purchasing or refinancing your home, you should understand the major differences in the types and terms of loans that are available to you.
Adjustable Rate Mortgages (ARMs)
Adjustable Rate Mortgages (ARMs) have interest rates that change during the life of the loan. When the rate changes and how much it goes up or down depends on the terms of the loan. These terms are disclosed to the borrower during the application process, and will be spelled out in detail in the loan closing documents.
If you are considering an ARM, you should understand how the terms of the loan may affect your monthly payment. When the interest rate goes up, your monthly mortgage payment will also increase.
ARMs can be a good option for a borrower that expects to live in their home for a short time (3-5 years). Someone who reasonably expects their income to increase significantly and wants to purchase a more expensive home than they would otherwise be qualified to buy might also consider an ARM. The ARM would be replaced with a stable fixed rate loan before the rate adjusts.
Fixed Rate Mortgages (FRMs) have a set or "fixed" interest rate that does not change during the life of the loan. Because the rate does not go up or down, the principal and interest (P&I) payment is consistent for the life of the loan.
Fixed rate loans generally have a loan term or length of 10, 15, 20, 30 or even 40 years. A loan with a shorter term will usually have a lower interest rate, but the payment will be higher since the loan amount is paid back over a shorter period of time. If you think you want to payoff your loan earlier, but don't want to commit to a higher payment, consider a 20 or 30 year loan. You can always pay extra principle, reducing the loan balance to pay off the loan faster.
For borrowers who want a stable payment and expect to remain in their home for at least 3-5 years, a fixed rate loan may be the best option.
Interest Only Loans allow a borrower to pay only the interest due on their loan for a certain period of time, often 10-15 years. Once the interest only period ends, the borrower must pay back the principal balance or refinance the loan. In some cases, the loan converts automatically to a principal and interest loan. Interest only options are available for both ARMs and Fixed Rate loans.
Balloon Loans have a lower P&I payment for the initial loan term, which is often just 5 to 7 years. The payment is based on a 30 year term, providing a lower payment than a traditional fixed rate mortgage. When the initial period is over, the loan "balloons" to a market interest rate and the payment goes up for the remainder of the loan term. Most borrowers chose to pay off the mortgage by selling or refinancing the home before that introductory period ends.
Home Equity Loans are used to access the equity or stored value in a borrower's home. These loans are structured as either a variable rate Home Equity Line of Credit (HELOC) or a fixed rate Home Equity Loan. With a HELOC, the borrower often uses the line of credit to pull cash out as needed for home improvements, college expenses or other costs that may vary over time. The payment on the HELOC changes depending on the outstanding balance of the loan and the current interest rate. With a Home Equity loan, the borrower receives a lump sum payment at closing, and the payments are consistent over the term of the loan, regardless of the loan balance.
