Types of Mortgages

Types of MortgagesThere are many different types of mortgages.  This section will focus on the more common products.

Fixed Rate Mortgages
The biggest feature of fixed rate mortgages is that the interest rate remains constant over the life of the loan.  This means that your monthly principal and interest payment will always remain the same through the term of the loan. These mortgages are usually appropriate for people who expect to remain in their homes for 10 or more years.  They offer peace of mind since you know what your payments are going to be.  Typical loans are for either 15 or 30 years.

Adjustable Rate Mortgages (ARMs)
Unlike fixed-rate mortgages, the interest rate and monthly payment move up and down as interest rates fluctuate. Generally, the initial interest rate is lower than that on fixed rate mortgages.

There are two components to the interest rate that a lender offers – the index and their margin.  The index rate is based on a certain index like the LIBOR.  This is the part that will fluctuate on a monthly basis.  The lender then adds a margin rate (their profit) to the index to get the interest rate.

The interest rate you pay will generally increase if prevailing interest rates go up, and vice versa.  Since your initial rate is lower, you can use an ARM to reduce your initial payments.

This type of mortgage mixes a certain initial fixed period with a latter adjustable period.  For example, a 3/1 ARM begins as a 3-year fixed rate loan.  After that period, the rate usually adjusts on an annual basis.  Other hybrid ARMs are the 5/1, 7/1, and 10/1 that are fixed for the first 5, 7, and 10 years respectively.  If you know how long you are going to be in a home, then a hybrid ARM may be a great way to lock in a rate lower than a traditional fixed rate mortgage.

An increasingly popular Hybrid option is what’s called “Interest Only”.  The loan basically works the same way as a regular hybrid except that you are only required to pay the interest on the loan.  You can choose on a month-to-month basis whether or not to pay any principal.  If you only pay the interest, your payments are lower, but your mortgage balance does not decrease.  This is a very flexible product.

Balloon Mortgages
The principal and interest payment remains constant over the term of a balloon mortgage which is usually 5-7 years, but the principal and interest are amortized over a 30 year period.  At the end of the 5-7 years, you will either have to pay off the mortgage or arrange for other financing (refinance).  The interest rate is usually lower than other traditional fixed rate mortgages so payments may be more affordable.  Like hybrids, this may be an appropriate product for people who know they are only staying in the home for a certain number of years.

The single-family mortgage loan limit for 2009 is $417,000.*  Mortgages that are within that range are called “conforming loans”.  If you need a mortgage higher than that limit, you will need a “jumbo mortgage”.  Since the lender is risking more money than a standard loan, you will usually find that jumbo loans come with high interest rates.

Note: Limits are 50% higher in Alaska, Hawaii, and the U.S. Virgin Islands.

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