Mortgage Types:
A Home Loan Overview

Today’s marketplace has an abundance of mortgage loan options.  Choosing the loan that is best suited for you can be confusing and difficult, especially when you are unfamiliar with the jargon.  Following are a few quick descriptions of basic mortgage types to help you gain insight in this area:

Fixed-Rate Mortgage

With a fixed-rate mortgage, borrowers get the security of knowing that their interest rate will stay the same throughout the life of the loan. This mortgage is especially popular when interest rates are historically low.   It offers the certainty of knowing exactly how much interest will be paid as well as protection against future increases in rates.  A downside is if market rates drop lower than the rate on the loan, payments will not drop accordingly.  Borrowers have to refinance in order to take advantage of lower interest rates.

Adjustable-Rate Mortgage

Also known as an ARM, an adjustable-rate mortgage works just like the name implies.  The interest rate varies throughout the term of the loan, adjusting up or down according to the index on which it is based.  Monthly mortgage payments follow suit.   The rate adjusts annually or on a schedule that the lender and borrower agree to.  Most ARMs have caps that limit the periodic increases in addition to the total increase over the life of the loan.   The starting rate of an ARM is typically lower than the going market rate.  This lets borrowers initially take advantage of lower rates and perhaps even qualify for a higher loan amount.  This lower rate comes with an assumption of risk of fluctuating, and potentially higher, future rates.

Hybrid Mortgage

This mortgage combines features of both fixed-rate and adjustable-rate mortgages.  A hybrid mortgage loan starts with a rate that is fixed for a period of time. When that fixed-rate period expires, the loan then converts to an ARM.   The initial rate for a hybrid mortgage loan is typically lower than prevailing fixed rates.   The lower rate enables more buying power up front.   On the risk side is the uncertainty of how high interest rates will be when the fixed-rate period expires.
 

Balloon Mortgage

A balloon mortgage generally has a short term, commonly anywhere from 3-7 years.  During that term, borrowers make regular equal payments of principal – the amount of money borrowed – plus interest.   At the end of the loan term, a “balloon” payment is due for the entire loan balance.  Options for handling the balloon payment include paying off the balance when due or refinancing before the payment comes due.   Balloon mortgages are usually offered at lower interest rates than other fixed-rate loans.  In addition, payments are calculated using a period longer than the term of the loan.  As a result, balloon loans offer affordability for short-term circumstances.  Borrowers do need to plan ahead so they are not caught unprepared when the balloon payment is due.

Interest-Only Mortgages

What is commonly called an interest-only mortgage is really an interest-only option that works with various mortgage types.  This option has regular payments, typically monthly, for a fixed period of time; however, payments consist of one hundred percent interest.   No principal is paid during the interest-only period.  When that period ends, the borrower is obligated to make payments of principal and interest.  Because the time remaining in the loan term to repay the principal is shorter than it would have been, payments will adjust upward, sometimes substantially.   The appeal of interest-only payments is savings.  When principal is not being paid, monthly payments are dramatically lower.  On the risk side is potential for loss.  If the need to sell arises and the property value has stayed flat or declined, a borrower might be in a position where the mortgage loan balance is higher than the market value of the property.

Government-backed Mortgages

The Federal Housing Administration (FHA) and the Veterans Administration (VA) do not make home mortgage loans.  They offer private lenders protection against loss from default.  The intent is to encourage lenders to offer qualifying borrowers more favorable terms than they might otherwise receive on loans.  The VA guarantees the loan when it is closed.  FHA insures the loan.  If a borrower defaults on an FHA loan, the lender is paid from an insurance fund.   Both FHA and VA loans have maximum limits in addition to other qualifying criteria.  Note that VA loans are for military veterans meeting established criteria.  FHA has traditionally been popular among first-time homebuyers, lower-income borrowers, or borrowers with limited down payments.

These are a few examples of basic mortgage types.  There are numerous loan programs available and many variations on terms within the types presented.   Your mortgage loan decision is an extremely important one that has current and future financial consequences.  When figuring out which loan makes the most sense for you, educate yourself.  Sources of mortgage information include financial web sites, mortgage books, articles, and consumer workshops.  Real estate professionals as well as mortgage lenders and brokers are also available to assist you in the education and selection process.

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