There are plenty of different types of mortgages available to the average homebuyer today. They all come with their own particular terms, rates and limitations. It can be daunting to think about sifting through all of the information about these loans to get the best fit. A loans officer or broker can help you with this process, but it’s also a good idea to learn about the common types of mortgages that are out there. Each has its advantages and disadvantages, depending on your particular financial situation. Here are some of the more common types of mortgages.
Fixed rate mortgages
With a fixed rate mortgage, you have a set interest rate that doesn’t change over time. The major advantage of these loans is that they make your payments constant and predictable. If market interest rates then rise, you don’t have to worry about your repayments becoming unaffordable. The flip side of this is that you’ll continue to pay at your fixed interest rate even if interest rates drop. You can set these loans up to be repaid over virtually any length of time up to 50 years. If you have a longer loan repayment period, your monthly payment will be smaller. However, you will also pay more interest in the long run.
Adjustable rate mortgages
With an adjustable rate mortgage, the interest rate on the loan fluctuates. It typically starts at a rate that is lower than a comparable fixed rate mortgage by one to three percentage points. After a year or so, the interest rate is adjusted to market levels. An adjustable rate mortgage is beneficial if you expect your income to increase in the future, or if you’re planning to be a homeowner for only a short period of time. Typically, there will be a cap placed on the interest rate, so it can’t exceed a maximum level.
Two-step mortgages
This type of loan combines the fixed and adjustable rate forms. For an initial period of about seven years, the interest rate is fixed. After this, it switches to an adjustable interest rate. The benefit of this type of mortgage is that it can offer a lower fixed rate than you would otherwise achieve. The disadvantage is that you can see a significant increase in the interest rate after the initial period.
Biweekly mortgages
With this mortgage plan, you pay half the monthly repayment on the loan every two weeks. This allows you to pay down the loan faster. It essentially amounts to paying the equivalent of 13 monthly payments per year, as you would have 26 biweekly payments annually. By applying each payment to the loan principal every two weeks, you also significantly reduce the amount of interest you pay over the life of the loan. Not all lenders will offer this type of loan, but it is a good option where available.
Convertible mortgages
A convertible fixed rate mortgage, or “reduced option loan,” gives you the option of adjusting your interest rate to a lower level by paying a fee based on the size of your loan. It works out to be significantly less expensive than the traditional refinancing option. Convertible adjustable rate mortgages are also available that allow you to switch to a fixed rate for a specified period of time if it suits you. This allows you to take advantage of the low initial rates on an adjustable mortgage, but still take advantage of a fixed rate option if rates drop.
Lender buydown
To reduce your interest rate during the first few years of your mortgage repayment period, it’s possible to set up a buydown agreement with your lender. By making a larger initial lump sum payment on the mortgage, you can decrease the starting interest rate and qualify for a larger loan. After this initial period of low interest, the rates rise to a predetermined level. Having a lower interest rate within the first three years or so can often help homebuyers by allowing them extra money for furnishings or home improvements.
VA mortgages
Veterans Administration (VA) loans are government mortgage plans available to those who served in the U.S. Armed Services. The main advantage of these loans is that you don’t need a down payment to qualify.
FHA mortgages
Federal Housing Administration (FHA) mortgages are another type of government loan open to everyone. They are particularly attractive to first-time homebuyers, as you don’t need a down payment and it doesn’t depend on your credit score.
Interest-only mortgages
With this type of mortgage, you only pay the interest on the loan for a set number of years. After the interest-only period, you then start paying off the principal on the loan. The benefit of this plan is that you get extremely low monthly payments at first. It’s also often possible to qualify for a larger home loan with this mortgage.