A No-Nonsense Guide to the Different Types of Mortgages (Part One)
When it comes to buying a home in 2018, the average American has more home loan options than ever before. Unfortunately, more choice isn’t always better. With many options come many questions, especially if you’re a first time home buyer and not a veteran of the mortgage game.
That’s why we’ve compiled our guide to the different types of mortgages. Here’s a peek at what you’ll be learning about in each section:
Part 1: Fixed Rate Mortgages vs. Adjustable Rate Mortgages
Part 2: Government Insured Mortgages vs. Conventional Mortgages
The first three sections talk about purchase loans, meaning loans that you’ll use to buy a home. The fourth section talks about loans used for other purposes -- like refinancing or accessing your home’s equity. Finally, the last section talks about lesser-known mortgages.
If you’re more of a visual learner, here’s our different types of mortgages infographic.
Fixed-Rate Mortgages vs. Adjustable-Rate Mortgages
The first choice you’ll have to make when deciding between the different types of mortgages is whether to go for a fixed rate or an adjustable rate. A fixed-rate mortgage means you can expect the same payment amount every month until your loan is paid off. An adjustable rate changes. It might give you a lower payment one month, and a higher one the next.
Both types of mortgages have their uses -- as well as their pros and cons. Let’s take a look at each.
Fixed Rate Mortgages
Fixed-rate mortgages (FRMs) are the bread and butter of the mortgage industry. The 30-year fixed-rate loan is the most common kind of home loan in America. Since interest rates on fixed-rate loans don’t change over the life of the loan, these mortgages provide more financial security than their adjustable-rate cousins.
The key, of course, is to lock in your interest rates while rates are low. Otherwise, you’ll simply be locking yourself into an overly expensive deal. In addition to the common 30-year fixed rate mortgage, fixed-rate home loans are typically available as 15, 20, 25, and 40-year mortgages.
Adjustable-Rate Mortgages
Unlike fixed-rate mortgages, adjustable-rate mortgages (ARMs), can go up or down based on market fluctuations. Most adjustable-rate home loans are adjusted once a year, though some are adjusted every six months.
While ARMs often are provided at a significantly lower starting interest rate than FRMs, ARMs are generally much riskier, since they could cause your monthly payments to increase.
Hybrid Adjustable Rate Mortgages
Most adjustable-rate mortgages are actually considered hybrid ARMs, meaning that the loan actually starts out at a fixed interest rate for a certain period of time. Then, it converts to an adjustable-rate, which is changed every six months or year..
Common hybrid adjustable-rate mortgages include the 3/1, 5/1, and 7/1 ARMs. For these ARMs, the interest rates are adjusted once a year after the fixed-interest part of the loan expires.
There are also 3/6, 5/6, and 7/6 ARMs, in which the interest rates are adjusted once every six months after the expiration of the fixed-interest portion of the loan.
Many borrowers get a hybrid ARM with the intention of selling their home or refinancing into a fixed-rate mortgage before the adjustable rate begins. That way, they can enjoy the low introductory rates offered by the ARM without having to actually deal with rising payments later in the loan.
Interest-Only Home Loans
The interest-only home loan is a mortgage that allows a borrower to only pay interest on the loan for a certain period of time. Interest-only loans can be a great option for borrowers who have extremely limited income right now, but are confident that their income will increase in the near future.
Otherwise, an interest-only home loan could be a risky choice, since you won’t be building any equity in your home for a certain number of years -- and you’ll have to start paying your principal at a certain point.
Up Next: Part Two of the Different Types of Mortgages: Government-Insured vs. Conventional Mortgages