Types of Mortgages
Loans of All Kinds
Now we’re getting into the nitty-gritty: the types of loans available. The chart below compares some of the most common loans. Following the chart, learn the details of some more specialized loans.
|30-year, fixed rate loan||Most common mortgage loan. For the first several years, the majority of your payment goes to interest. Later payments are applied more to the principal.||Because the rates and monthly payments are fixed, your house payments stay consistent.||May miss out on a great rate because your loan is fixed. You will also spend the first years paying the interest only.||Although fixed mortgages are typically offered at a 30-year rate, 15-year and 40-year lengths are also available.|
|A.R.M (Adjustable Rate Mortgage)||A.R.M.s adjust periodically based on the current interest rate.||You might qualify for a larger loan, since initial payments are often lower than with a fixed-rate. It can save money if current interest rates are lower than fixed rates. It's usually a good bet if you plan to sell soon||As the rate adjusts, monthly payments can vary greatly over time. If interest rates rise above the fixed rate, you may end up paying significantly more in the long-term. It's much more complicated than a fixed-rate mortgage
||Initial interest rates are artificially low—learn about the index and margin, which affect your interest rate. Learn what the limits (rate caps) are on rate adjustment. Note negative amortizations, which would lengthen the life of your loan|
|Hybrid||A loan that begins as a fixed-rate mortgage and changes after a pre-determined amount of time into an A.R.M.||Best if you don’t plan to stay in your house for more than the initial, fixed-rate period
- Like with A.R.M.s, the hybrid offers buyers a chance to buy more
|Flexibility of the hybrid loan may result in higher interest rates if you stay in your house past the initial rate period
- When the loan switches from a fixed-rate to an A.R.M., that new payment could be much higher
|For example, a 30-year hybrid loan may be a 7/23—a fixed-rate loan for the first seven years, and an A.R.M. for the remaining 23 years. Many other options exist, such as a 2/28 or 5/25, etc.|
|Sub-prime or non-prime loans||Mortgages available for people with problematic credit histories—usually with a credit score below 620—who would not be able to get a mortgage otherwise||If you have poor credit, this may be your only option for buying a house||Typically a higher interest rate than that offered to those with good credit
Penalties (balloon payments, prepayment penalties) may be part of the loan terms
|Often the targets of predatory lending—a practice where unethical lenders burden the borrower with fees and costs with the intention of eventually foreclosing on the property and selling it again|
Example of Fixed Rate Mortgage
Through the life of a mortgage loan, where your payments are applied varies. In the first few years, the majority of your payment goes to interest. By the last few payments, nearly all of the money is going toward the principal. Here's how the principal and interest change over the life of a loan:
(Example of a 30-year, 7.5% fixed-rate mortgage of $150,000)
|Payment number||Principal balance||Payment amount||Interest paid||Principal applied||New balance|
(next to last)
An A.R.M. and A Leg
For an actual example of how the variable interest rates of A.R.M loans can affect your monthly payments, take a look at the table below.
|Year of A.R.M.||Rate||Monthly Payment|
|Fourth Year||11.75%||$1380 ($580 more than the first year)|
Example of A.R.M. vs Fixed Rate
|Interest Rate Over 4 Years||Total Payments Over 4 Years|
|A.R.M.: 5.75% to 11.75%||$57,036|
|Fixed rate: 7.75%||$51,600|
|Savings with fixed-rate mortgage over 4 years:||$5,436|
The Specialist: More Unique Loans
The majority of mortgage loans will fall into the categories mentioned in the table above. However, some borrowers may prefer more specialized versions of those loans or a loan that is unique to a certain home-buying situation. These include:
- Interest-only. Interest-only loans put all of your early mortgage payments straight to the interest, making no in-roads on the principal. These initial payments (usually the first three to ten years) are lower than your eventual monthly payments and are also fully tax deductible.
- Jumbo. There are two federal government organizations (Fannie Mae and Freddie Mac) that set loan limits. If a loan falls within those limits, it’s considered a “conforming” loan. If a loan exceeds those limits, it is a jumbo loan. Jumbo loans usually require a larger down payment (often 25%) and interest rates are higher.
- Assumable. With this type of loan, the selling homeowner can hand over the house and loan to the buyer, instead of paying off the loan from the sale proceeds. This type of loan, although rare, can be useful if rates rise, as buyers may be willing to pay more for the house to get the lower loan rates in the bargain.
- Construction. These loans are for people who are building a home rather than buying an existing structure. They are usually a two-step loan with higher rates during construction and a traditional fixed-rate mortgage after the house is built.
- Balloon. A balloon loan involves the garden-variety, fixed-rate payments, but (here’s the tricky part) the principal balance of the loan is due at some point before the maturity date. Your initial payments may be smaller and interest rate lower, but if the loan balance comes due and you aren’t prepared, it could spell real financial trouble.
- Seller financing. W ith this option, the seller offers the buyer a loan for either full or part of the home’s price. Approach with caution: Why is the seller so willing to help you buy? This is often appealing to buyers with poor credit who would get turned down for conventional mortgages or who want to save on time and closing costs.
In the next section, we’ll discuss the potential timeline for buying a house. Namely, how much money you have saved for your down payment, how that will affect your mortgage, and whether you should wait or buy now.