Choose the type of Home Mortgage Loan that makes sense for you
It may take a little time to understand all of your loan choices and figure
out which one is the best fit for your situation. We’ll help you gain an understanding
of the loans that are available and give you the knowledge to make decisions based on your
best interests.
You should have an idea of the type of loan you want – but you need
to know the type of loan you don’t want. We’ve listed most of the common
loan types below along with details about each to help you determine which one is right for you.
30 Year Fixed
These are mortgages where interest and mortgage payments remain the same for 30 years, at which time
you will have paid back the entire loan.
Who is this good for?
Those who prefer the security of fixed-monthly payments like fixed-monthly mortgages. Often,
these mortgages are more expensive than their adjustable-rate counterparts, but they are easier
to understand and provide the greatest payment stability. If you can afford this loan and plan
to be live in your home for 10 or more years, this may be the best option for you.
| What can happen to your payments? |
Can your balance increase? |
What are the risks? |
What are the good points? |
| Your payments remain the same for the entire term of this loan. There won’t be
any adjustments that would cause your monthly payments to change. |
No. Because you’re paying both interest and mortgage each month, your balance
decreases with each payment. |
A fixed-rate mortgage is generally considered a risk-averse mortgage because your
payments remain the same regardless of market rate changes. The only risk occurs if rates
fall dramatically. To take advantage of better rates you have to refinance, which costs money. |
The attraction to fixed-rate mortgages comes from knowing
that your payments will not change over time. This stability can help you manage your budget
since you know that your mortgage payments will be the same each month. |
15 Year Fixed
These are mortgages where interest and mortgage payments remain the same for 15 years, at which time
you will have paid back the entire loan. These loans offer the lowest fixed rates but have the
highest monthly payments because you are paying off the loan in a shorter timeframe.
Who is this good for?
Payments are higher with 15-year fixed, can you afford to build equity that quickly?
Those who prefer the security of fixed-monthly payments and can afford the higher monthly
payments of a 15-year term like this mortgage. You will build equity quickly, but the high monthly payments may
restrict the overall price of the home you can afford.
| What can happen to your payments? |
Can your balance increase? |
What are the risks? |
What are the good points? |
| Your payments remain the same for the entire term of this loan. There won’t be
any adjustments that would cause your monthly payments to change. |
No. Because you’re paying both interest and mortgage each month, your balance
decreases with each payment. |
A fixed-rate mortgage is generally considered a risk-averse mortgage because your
payments remain the same regardless of rate changes. Because 15-year fixed mortgages have
an expensive monthly payment, the main risk comes if your situation changes, causing you
to have difficulty with the high mortgage payments. |
The attraction to fixed-rate mortgages comes from the peace
of mind that your payments will not change over time. This stability can help you manage
your budget since you know that your mortgage payments will be the same each month. You
also build equity more quickly in a 15-year than in a 30-year and pay much less in interest
over the life of the loan. |
ARMs
Adjustable-rate mortgages (ARMs) are mortgages where the interest rate you pay adjusts at
a specified time and frequency. There are many different ARM products, but generally they
offer a lower initial rate than a 30-year fixed and they adjust with market trends. Therefore,
when your initial rate period ends and your ARM is ready to adjust you may be paying more
(with higher current market trends) or less (with lower current market trends) than your
initial rate. Generally, ARMs follow this pattern: the shorter the initial term, the lower
the initial rate.
How do adjustments work?
Adjustments vary on the type of ARM, but you can identify the initial rate period by the
first number and the adjustment frequency by the second number. A 3/1 ARM means the same
initial rate for 3 years and an adjustment once every year after that. The following table will
help you understand how adjustments work:
| 7/1 ARM |
Same initial rate and payment for 7 years, then on the 8th year the rate and payment
adjusts once and continues to adjust once each year for the remainder of the loan. |
| 1/1 ARM |
The rate changes once each year for the entire term of the loan. |
| 3/3 ARM |
Same initial rate and payment for 3 years, then on the 4th year the rate and payment
adjusts and continues to adjust once every 3 years for the remainder of the loan. |
Who is this good for?
See the difference between a low adjustable rate and a standard adjustable rate for your situation.
If you are planning on selling your home in a given time frame an ARM might make sense.
Let’s say you are planning on moving in 5 years, a 5/1 ARM could work well because it
provides a lower rate and monthly payment, and when it is ready to adjust after 5 years, you
won’t experience a payment change if you sell your home.
Savvy investors like ARMs (or really any mortgage that puts more cash at their disposal
each month) because instead of paying higher monthly mortgage payments, they can use that
extra money to make higher-yielding investments.
| What can happen to your payments? |
Can your balance increase? |
What are the risks? |
What are the good points? |
| Your payments will stay the same for the initial period and adjust with market trends
according to the type of ARM. For example, your rate will change on the 6th year of a 5/1
ARM – they may go up or down depending on the market. |
No. Because you’re paying both interest and mortgage each month, your balance
decreases with each payment. |
If the market trend skyrockets after you buy your ARM, you may be paying much more
when your adjustment occurs. ARMs are considered riskier than fixed because you have no
guarantee on your future payments. |
ARMs commonly have a lower initial rate than fixed-rate
mortgages. These lower initial payments might help you buy a home that you couldn’t
afford with the higher payments of a fixed-rate loan. Also, if you believe rates will
drop, you won’t have to refinance to take advantage of them. |
Interest Only
These are fixed or adjustable rate mortgages where you the option of paying interest only for a
specified term, usually five to ten years. After the initial term the mortgage switches to
a fully-amortizing mortgage for the remainder of the loan. Let’s say you had an
interest-only option for the first 7 years of a 30-year fixed loan. At the beginning of
the 8th year, you would have to pay interest and principal for the full amount in the
remaining 23 years. Often, at the end of the initial interest-only period, you would
refinance instead of paying the high monthly mortgage payments.
Who is this good for?
Interest-only mortgages make sense for people who expect their financial situation to
change in the near future. Young professionals like doctors and lawyers may also prefer
this mortgage since they believe they will be making significantly more money in the future
than they do now. Or parents who have children graduating from college soon might like this
loan since they expect to have fewer expenses in the near future.
Those who prefer to use the extra cash for investments rather than mortgage payments
also like this mortgage.
| What can happen to your payments? |
Can your balance increase? |
What are the risks? |
What are the good points? |
| Interest-only loans are set up so you have the option of paying only interest or
paying both interest and principal. At the end of your interest-only period, your
payments will greatly increase. |
No. Your balance does not increase with interest-only mortgages. Of course, if
you choose to pay only interest each month, the balance doesn’t decrease either. |
If your house does not appreciate as you expected, your refinancing options could
be limited when your interest-only period ends. If you don’t refinance, you could
be stuck with very high mortgage payments. |
This loan provides payment flexibility as you can pay
interest only, or both interest and principal each month. You can also afford more home
because of the lower initial payments – which makes sense if you know you’ll
have enough income to pay the higher payments when the initial interest only period ends. |
Payment Option “flex pay”
These are mortgages where you have the option of paying different amounts each month. Usually, the
monthly payment options include a low payment option, an interest-only option and an interest
plus principal option. The low payment option creates negative amortization and usually
adjusts yearly with a maximum rate cap.
Who is this good for?
People that do not have steady incomes may like this loan. It provides the most
flexibility from month to month. For example, a salesperson that gets commissions quarterly
can pay interest only for 3 months and then, when they receive their commission, pay both
interest and principal for the entire quarter. This allows the salesperson to pay their
mortgage down in a way that meets their specific income schedule.
Those who prefer to use the extra cash for investments rather than mortgage payments
also like this mortgage. The payment options provide flexibility, but you should be certain
that you have financial discipline before taking on this loan.
| What can happen to your payments? |
Can your balance increase? |
What are the risks? |
What are the good points? |
| You have options for your payments with this mortgage, but in general, the low
payment option remains the same for one year then increases with the market trends.
The other options are tied to an index and will increase or decrease monthly. |
Yes. If you elect to pay the low payment option, you will be negatively amortizing
your mortgage, meaning the amount you owe will go up over time – sometimes dramatically. |
If you only pay the low payment option and your house does not appreciate as you
expected, you could end up owing more on your home than it’s worth. If the housing market
does not appreciate as you expect, you could have few options for refinancing or selling your home. |
You have payment options each month. |
Balloon
These are fixed short-term mortgages that follow an amortization schedule like traditional long-term
fixed mortgages. Balloon terms are commonly 3, 5 or 7 years during which you are paying both
interest and mortgage. At the end of the term you’d have to pay off the resulting balance,
usually by refinancing. However, some balloon loans also allow you to convert to a long-term
fixed at the end of the initial term.
Who is this good for?
Balloon mortgages work for people that like the stability of fixed payments but can’t
afford a long-term mortgage. Also, if you are planning selling your home in a given time frame
a balloon mortgage might make sense. You can compare the rates between balloons and ARMs to see
which can give you the best interest rates. Since you’ll be moving at the end of the term
anyway, you won’t need to worry about paying off the balance – providing of course
you can sell your home for more than the balance.
Savvy investors also like balloons (or really any mortgage that puts more cash at their disposal
each month) because instead of paying higher monthly mortgage payments, they can use that extra
money to make higher-yielding investments.
| What can happen to your payments? |
Can your balance increase? |
What are the risks? |
What are the good points? |
| Your payments remain the same for the entire term of this loan. There won’t be
any adjustments that would cause your monthly payments to change. |
No. Because you’re paying both interest and mortgage each month, your balance
decreases with each payment. |
At the end of the term, you are responsible for repaying the full remainder of the loan.
This means that you will either have to refinance or convert the balloon loan into a long-term
fixed. You won’t have the option of waiting for better market conditions if the rates
are high so you could get stuck with large monthly payments. |
The payments are fixed and you’ll get a lower interest
rate than you would with 30 or 15-year fixed mortgages. |
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