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Types of Home Loans - A Buyer's Guide to Home Mortgage Loans

by Brandon Cornett


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"What type of home loan should I get?"

This is one of the most common home buying questions among home buyers -- especially with first-time home buyers. It's a common question for good reason. Choosing a type of home loan is one of the most important decisions you'll make during the home buying process, second only to the home itself.

Believe it or not, choosing the right type of home mortgage loan is fairly straightforward, once you understand the pros and cons of each type of home loan. It's just a matter of thinking ahead and considering your financial situation.

This article will help you do the kind of thinking necessary to choose the best type of home loan for your unique situation.

What is a Home Mortgage Loan?

We like to be thorough here at the Home Buying Institute. So we'd like to start off with a mortgage definition, just so we're all on the same page. Of all the books and articles I've read on the subject of home loans, the best mortgage definition I've read was in Home Buying for Dummies, by Eric Tyson and Ray Brown.

In their book, Tyson and Brown explain that "a mortgage is nothing more than a loan that you obtain to close the gap between the cash you have for a down payment and the purchase price of the home..."

You have a certain amount of money. The home costs a certain (larger) amount of money. The home mortgage loan covers the distance between the two.

It's important to start thinking in these "distance" terms, because a lot can happen to the economy during the life of your home mortgage loan. How much these factors affect your mortgage depends on the type of mortgage loan you choose. Aha! Now it all starts to come together.

The Major Types of Home Loans

Let's start with the biggest difference between home loans … fixed-rate vs. adjustable-rate. With a fixed-rate mortgage loan, your interest rate will never change, regardless of what the economy does. On the contrary, adjustable-rate mortgages (ARMs) have interest rates that adjust periodically during the life of the loan.

Terminology note: Adjustable-rate mortgage are also referred to as having a "variable rate." But the more common usage is adjustable-rate mortgage, or the acronym ARM.

There are many different types of home loans, but to an extent they can all be classified as either fixed-rate or adjustable-rate. So the important thing is to be sure you understand the definitions, as well as the pros and cons, of fixed-rate and adjustable-rate home loans. If you start with a good grasp of this concept, things will be much simpler as we continue learning about the types of home loans.

Fixed-Rate Mortgage Loan: Pros & Cons

As the name suggests, a fixed-rate mortgage is a mortgage where the interest rate stays the same over the life of the loan. As a result, your monthly mortgage payment does not change.

Certainty is the primary benefit of a fixed-rate mortgage loan. You always know what your interest rate will be, regardless of what the economy does. The downside is that you'll pay a premium for this predictability, in the form of a higher interest rate.

When a mortgage lender grants a fixed-rate loan for a long period of time (like 30 or 40 years), they take on a certain amount of risk. If the prime interest rate goes up during the life of your loan, you will not have to pay the difference -- the lender will. This is why they charge a higher interest rate than with an adjustable-rate mortgage (next topic).

Learn More About Fixed-Rate Loans


Adjustable-Rate Mortgage (ARM) Loan: Pros & Cons

These days, most adjustable-rate mortgages start off with a fixed rate for an initial period of time, usually 3, 5 or 7 years. During this introductory period, the interstate rate is fixed and will not change. After the introduction period, however, the loan converts to an adjustable-rate.

Overall, the interest rate on this type of home loan is lower than a traditional fixed-rate mortgage. The downside is that you can never predict the interest rate it will adjust to after the introductory period. So in this regard, you can think of the initial period as a reward for the uncertainty of the adjustable period. You will start off with a lower interest rate than a regular fixed-rate loan, but you have the uncertainty of the adjustment phase.

During the adjustable phase of the mortgage, your monthly payments will rise and fall with average interest rates. It would be great if they fell, but bad if they rose. The important thing to remember is that you'll have no way to predict the average interest rates in advance, so the adjustable nature of the loan is something of a gamble.

Learn More About ARMs


Balloon Loans

A balloon loan (also referred to as a "reset mortgage") starts with a fixed interest rate for a certain number of years. But unlike traditional fixed-rate mortgages, the interest rates on balloon loans are nearly as low as those found on adjustable rate mortgages (ARMs).

The problem with balloon loans is the term. The initial fixed-rate period of a balloon is usually 7 to 10 years. After that, you have to pay off the loan's remaining balance in full. Obviously, that's a large sum of money to pay at one time! Typically, people refinance their balloon loans prior to this stage, but there's no guarantee what interest rate you'll get when refinancing.

Learn More About Balloon Loans


Additional Mortgage Resources

We hope this tutorial has helped you better understand the different types of home loans. More importantly, we hope it has put you on a path to learn even more about the different types of home loans, because you can never know too much about something as important as a mortgage loan. Here are some additional resources we'd like to leave you with:


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Brandon Cornett is the publisher of Home Buying Institute.