The Three Main Mortgage Types
In the world of securing a mortgage loan, barrowers have far less in terms of choice in the type of loan they get compared to even a few years ago. Why? Well, the real estate bubble burst and the ensuing fallout which put the country on the brink of another Great Depression would be the reason. When times were good the banks were much more willing to get creative to help pretty much anybody get into a house they couldn’t afford. You may have hear the term “sub-prime” used to describe these high risk loans. The result has been a complete 180 degree turn back to the fundamentals of sound home loans going only to worthy homebuyers with great credit and sizable down payments.
What’s left are the most basic loans: Fixed Interest, Adjustable Interest, and Interest Only.
In a fixed-rate mortgage, the interest rate does not change over the entire term of the loan and the payments are split into equal monthly payments for the duration.
The interest payments are weighted toward the beginning payments of the loan which mean that for the first few years of the loan term, a low percentage of the payments made will actually go toward paying off the principal.
Adjustable-rate mortgage (ARM)
The exact opposite of a fixed rate mortagage is the adjustable rate mortgage. With this kind of loan the your interest rate changes every year.
It is important to be able to understand the index that the loan’s adjustable interest rate ins based upon.
An index is a measure of the cost of money based upon the market rates. A bank’s loans are based on will be tied to a specific index. There are many different indexes that banks use to calculate the rate on ARMs. The most frequently used indexes are the one-year Treasury Constant Maturity, the London Interbank Offered Rate, Libor, and the 11th District Cost of Funds Index.
With this kind of loan there is usually an initial fixed-interest period that makes the payment seem great which get you to sign the loan docs, but once the rate adjusts the payment can increase significantly and may no longer be affordable.
There is also a margin on a loan is the amount that will be tacked on to the index interest rate to come to the actual interest rate you will pay.
The interest rate will adjust regularly, but there is normally a fixed limit to the total amount it can fluctuate both up and down. Often there will be a cap on the introductory interest rate that is set higher than all of the future interest rate adjustments, and also a cap on the amount the rate can change over the life of the loan.
Barrowers that are interested in a really lowest possible payment for several years may end up taking an interest-only mortgage. This kind of loan product makes it possible for you to pay only the interest portion each month.
Interest-only loans are essentially another form of an adjustable-rate mortgage.
Before you take on any kind of mortgage be sure to read the fine print and make sure you understand what could happen should the market change and rates go up.