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Mortgage & Credit >> Types of Mortgages >> Understanding Mortgages
Understanding the Different Types of Mortgages
by Brandon Cornett
Fixed Rate Mortgage
A fixed-rate mortgage offers an interest rate that will never change over the life of the loan. The primary benefit is that if interest rates increase during the term of your loan, your rates stay the same.
On the other hand, if interest rates drop during the term of your loan, your rates still stay the same (unless you refinance your home at the lower rate). This is the biggest difference between this loan and variable / adjustable loans (see next item).
The length (or "term") of a fixed-rate mortgage can be 15, 20 or 30 years. Each of these terms has its pluses and minuses:
- 30-year fixed rate - The 30-year term gives you maximum tax advantage by having the greatest interest deduction. It's also worth noting that the 30-year fixed-rate loan is often the easiest type of loan to qualify for.
- 20-year fixed rate - If you shorten your mortgage, you usually get a lower interest rate. The 20-year mortgage is not as common as the 30-year, so you'll have to shop around to go this route.
- 15-year fixed rate - Same benefits as the 20-year term (quicker payoff, lower rates), but will increase the monthly amount you pay.
Adjustable Rate Mortgage (ARM)
The adjustable rate mortgage (or "ARM") offers a fixed initial interest rate with a fixed initial monthly payment. "Initial" is the key word here, because after some predetermined initial period, the loan is subject to changes in market conditions.
The initial interest rate you pay will probably be lower than a fixed-rate mortgage; but the uncertainty, of course, comes after the initial period. This type of loan is usually a good option for buyers who only plan to stay in a home for a short while.
In other words, if you turn around and sell the house before the initial fixed-rate period expires, you'll benefit from the lower rate and be out before the uncertainty sets in.
How often the interest rate adjusts with an ARM depends on the terms of the loan. Take the 5/1 ARM as an example. 5/1 means your interest rate would stay the same for the first five years and then adjust each year starting at the sixth year. A 3/3 ARM would offer an initial fixed rate for three years and would then adjust every three years starting at the fourth year.
Balloon Loan
The balloon loan is a short-term, fixed-rate loan that lets you make small payments for an introductory period of time. After the introductory period - usually five, seven or ten years - you must refinance or pay off the remaining balance with one lump-sum ("balloon") payment.
Government Loans (FHA, VA, RHS)
FHA Loan - A loan insured by the Federal Housing Administration, open to all qualified homebuyers. There are limits to the size of FHA loans, but they are usually enough to cover most moderately priced homes. FHA loans also offer low down payments (usually 3-5 percent).
VA Loan - A long-term, low or no-down-payment loan guaranteed by the Department of Veterans Affairs. Because this loan is insured by the VA, it has the added benefit of zero down payment. This type of loan is only available to qualified military veterans who have obtained a certificate of eligibility from the Department of Veterans Affairs.
RHS Loan - The Rural Housing Service (RHS) loan offers low interest rates with no down payment. It is available to households with low to moderate income located in rural areas or small towns.
Brandon Cornett is the editor of HomeBuyingInstitute.com, one of the Internet's largest and most respected libraries of home buying information. Put hundreds of home buying strategies at your fingertips by visiting www.HomeBuyingInstitute.com.
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