If you’ve decided to buy a house, one of the most important steps is figuring out what type of financing is right for your particular situation. A house is typically the largest loan you’ll ever have, and the interest payments can exceed the price of the actual house. Savvy shopping can save you thousands, tens of thousands, or even hundreds of thousands of dollars on your mortgage interest.
There are four or five basic types of mortgage loans, depending on how you count. There are fixed rate mortgages, adjustable rate mortgages (ARMs), balloon mortgages, and special ARMs.
Fixed Rate Mortgages
Your regular, generic mortgage is a fixed rate mortgage. This means that your interest rate will not change during the life of the loan, so the principal and interest portion of your mortgage payment will not change. The most common terms for fixed rate mortgage are 15 years or 30 years. Fixed rate mortgages are great because your mortgage will not change, allowing for better budgeting and more predictable expenses.
Adjustable Rate Mortgages
Adjustable rate mortgages, commonly called ARMs, are subject to rate changes that are tied to a specific financial indicator. The interval at which the rate may change is indicated in the mortgage; commonly six or 12 months. If the interest rate goes up, so will the principal and interest portion of your mortgage payment. The same is true if the interest rate goes down. ARMs often have initial interest rates that are lower than fixed rate mortgages. ARMs can be great for those who can handle a dramatic large increase in payment amount or who plan to sell very quickly.
A balloon mortgage is a particular type of mortgage that is out of fashion right now. With a balloon mortgage, the mortgage has a fixed rate, and is amortized over 15 or 30 years just like a regular fixed rate mortgage. However, balloon mortgages are designed to terminate after a shorter term, typically 5 or 7 years. At the end of the term, the entire principal balance is due. The advantage of balloon mortgages is that they have a lower interest rate than a regular fixed rate mortgage. Balloon mortgages are good for people who are absolutely, positively sure that they will sell or otherwise have a large sum of money available before the term is up. (I don’t know about you, but I am rarely absolutely, positively sure about anything. Especially not when it comes to real estate.)
A buydown mortgage is very similar to a fixed rate mortgage, except that the interest rate has been lowered for the first few years of the loan by a large payment at the beginning. Buydown mortgages are popular in situations where a borrower anticipates large jumps in repayment ability during the first few years. A typical buydown might have the interest rate one percent lower for the first year, then one percent lower for the second year, then at market rates for the third and subsequent years. Frequently, a home seller may buy down the interest rate in order to help entice a buyer to purchase a house.
There are many types of special ARMs. The most common scenario involves limits on when and how much the interest rate can change. These are expressed as a series of numbers, usually two numbers. The first number indicates how long the introductory interest rate will remain unchanged. The second number indicates how often the rate can be changed. Many ARMs also have a limit on how much the rate can be changed with each change. Special ARMs often offer very attractive terms and can be a great way to save money in specific circumstances.
Knowing your mortgage loan types can help you to make a good decision about what is right for your borrowing situation. The right loan can save you a lot of money over the life of the loan. If you are at all confused about your choices, do your research or ask for help. Big money is depending on it!