Most people that want to buy a home will need to take out a mortgage to pay for it. Unless you have the cash available to buy your new home outright it is the only viable alternative. It is a very big decision to buy a new home. So we want you to understand the most common type of mortgage loans available so you can decide which one makes the most sense.
You need to understand that there are many different types of mortgages available and this can make choosing the right one for your situation quite a challenge. Mortgages vary by interest rate and the repayment term and there are other factors too. We will try and make this clear to you in article about the most common types of mortgage loans.
A Fixed Rate Mortgage
Of all the types of mortgage loans available this is the most popular. As the name suggests, a fixed rate mortgage means that the interest rate will always remain the same for the entire duration of the loan. Fixed rate mortgages are so popular that they account for 75% of all loans for home purchases in the United States.
You usually have the option to go for different term lengths with fixed rate mortgages. There is usually a 10 year repayment option, a 15 year repayment option and a 30 year repayment option. Although the 30 year repayment option is the most popular choice, the 15 year option will mean that you pay a lot less and create equity in your home a lot quicker.
If you go for a fixed rate mortgage over a 15 year repayment term then your monthly repayments are going to be higher than if you chose a 30 year repayment term. But you will pay a great deal less in interest. The higher the mortgage loan amount the more interest you will save. It’s all common sense really.
The obvious advantage of the 30 year fixed rate mortgage is the lower monthly repayments. This can be really attractive to first time buyers who do not have the budget to pay a lot more. This is fine but if you want to move to another home and sell your existing one before you have paid off the mortgage then you may not have the equity available.
Advantages and Disadvantages of a Fixed Rate Mortgage
A fixed rate loan brings certainty which a lot of people want and it is the number one reason why it is king among the different types of mortgage loans available. When you first agree your fixed rate mortgage your lender will make you aware of the interest rate. This will not change at any time during the term of your mortgage.
The only real disadvantage of a fixed rate mortgage is if the broader interest rate falls significantly. If this does happen then most lenders will allow you to refinance your home again at lower rates. If you choose to do this then you will normally have to pay closing costs for your original mortgage. Some lenders may waive these charges in order to keep you as a customer.
Adjustable Rate Mortgages are Popular Types of Mortgage Loans
Some people will go for an adjustable rate mortgage (ARM) because it allows them to make smaller repayments at the beginning of the term. Basically an ARM is a loan where there is a specified period after which the interest rate will change. If you are considering an ARM then you need to understand that it is riskier than a fixed rate mortgage.
The main reason that ARM’s are popular types of mortgage loans is because the interest rate will be lower than that of a fixed rate mortgage initially. If interest rates do not change this is fine as you can actually purchase a more expensive home by using an ARM. But if there is a jump in interest rates then this could mean that you can no longer afford your repayments.
If you intend to sell your home quickly then an adjustable rate mortgage may be a good choice for you. If you have an ARM then our advice to you is to pay more than you need to on a monthly basis in order to create equity in your home which provides a degree of protection if interest rates suddenly shoot up.
Common Terms for Adjustable Rate Mortgages
There are different ARM’s available and you need to know about these types of mortgage loans so that you can go for the best one. A 10/1 ARM is a 30 year mortgage where the first 10 years have a fixed interest rate. The interest rate adjusts each year after the initial 10 year period.
You can also go for a 5/1, 5/5 and 5/25 option with an ARM. With all of these options the initial low interest rate does not change for the first 5 years. With a 5/1 the rate adjusts every year after the first 5 have elapsed, and a 5/5 has an interest rate adjustment every 5 years after the initial 5 year fixed period.
The 5/25 is a bit different and you will sometimes see this type of ARM referred to as a “30 due in 5” home loan. There is a fixed 5 year rate at the start and then one change of interest rate in year 6 which continues for the rest of the loan period. There are also 3/1 and 3/3 ARM’s available.
Which of the Popular Types of Mortgage loans will you go for?
Now that you know how the most common types of mortgage loans work it is time for you to decide which one is best for you. Do your homework and calculate what you can comfortable afford each month. If you want predictability then go for a fixed rate mortgage.