Shopping around for a home loan can be a confusing process, especially for first time home buyers. This guide explains the most common types of mortgages available.
As the name implies, fixed rate mortgages have a fixed interest rate that does not change over the life of the loan. This has several benefits over other types of loans. The first benefit is that you can lock in a low interest rate and it can never change for the life of the loan. Another benefit is because the interest rate stays the same, your monthly payment will always be the same and will not fluctuate up or down with changes in the current market.
The most common fixed rate mortgages are typically 15 year loans and 30 year loans. A 15 year loan will mean that you have higher monthly payments, but also means that you will pay off your loan 30 years sooner and pay thousands less in interest over the life of the loan. The benefit of going with a 30 year loan is that your montly payments will be lower.
With any fixed rate loan you should check with the bank and make sure there is no penalty for paying extra on the loan. This is referred to as a prepayment penalty, which means the bank can charge you money if you pay extra toward your loan at any time. You should shop around until you find a loan without a prepayment penalty so that if you have extra money you can make an extra payment and have it applied to the principle.
Again, as the name implies and adjustable rate mortgage means that the interest rate on the loan occasionally is adjusted over the life of the loan to keep it in line with current market trends. The benefit of an adjustable rate mortgage is that if the current market rate drops low, the interest rate on your loan will also drop. However, this can also backfire because if interest rates go up that means that your interest on your loan will also go up. Not only does this mean that you will pay more interest on the loan, but it can also mean that your monthly payment will increase.
Adjustable rate mortgages typically start with a fixed rate for a period of several years, then switch to an adjustable rate. For example, a 3/1 ARM (adjustable rate mortgage) has a fixed rate for 3 years, then the rate is adjusted once a year for the remaining term of the loan. A 5/1 ARM has a fixed rate for 5 years, then again adjust the interest rate every year after that.
A convertible mortgage loan is an adjustable rate mortgage that allows you to convert it to a fixed rate mortgage at or before a specified time. The benefit of this is that you can wait for interest rates to drop, and then can lock in a lower rate before committing to a fixed rate loan. The downside is that if interest rates go up and not down you may wind up having to lock in at a higher rate than you would have gotten if you had just gone with a fixed rate loan to begin with.
These loans are often interest-only loans. This means that your payments are only applied to the interest, which leaves the entire loan amount to be paid off at the end of the term of the loan. The benefit of a balloon loan is that it allows you to keep your monthly payments as low as possible until you refinance. Additionally, a larger share of your payment may be eligible for the mortgage interest tax deduction. The downside is that if you never refinance you will wind up having to pay off the entire balance of the loan in one large lump sum at the end of the loan term.