Explaining Different Types of Mortgages & What They Mean for

Explaining Different Types of Mortgages & What They Mean for You

No matter if you’re buying your first home or an experienced homeowner, selecting the appropriate mortgage type can make a big difference. Factors like interest rate, length of loan, down payment amount and borrower qualifications all play into making your choice.

Fixed rate mortgages, also referred to as conventional loans in the US, make up two thirds of all mortgage loans issued. They’re typically issued over 30, 15 and 10 years; however, shorter-term options exist too.
Fixed Rate Mortgage

One of the most popular mortgage types is a fixed rate mortgage. These loans usually have terms of 15 or 30 years.

A major advantage of a fixed-rate mortgage is that the interest rate and monthly payments remain fixed throughout the loan’s term. By eliminating worry about changing interest rates, borrowers can focus on other financial goals and expenses without worrying about them changing.

Interest rates are determined by a variety of factors, such as Treasury bond movements, the mortgage lending industry and your personal finances (credit score, outstanding debt and income level). You can protect yourself from market interest rate hikes with a fixed-rate mortgage.

Though a fixed-rate mortgage may have higher interest rates than its adjustable-rate counterpart, they offer greater predictability and dependability. Furthermore, this allows borrowers to budget for their mortgage payment as well as other expenses more easily.

Fixed-rate mortgages offer stability in terms of interest rate, as long as the borrower keeps their payments current and pays their loan off on schedule. They’re an attractive option for buyers who don’t mind making higher monthly payments but want the peace of mind that their original agreed-upon amount in interest will never increase.

Are you considering buying a home but unsure which mortgage type is ideal for you? Consult a qualified mortgage expert. They can assist in determining which loan option best meets your needs and lifestyle.

In addition to your monthly payment, other costs associated with homeownership must also be taken into account, such as property taxes, homeowners insurance and HOA fees. Therefore, it’s essential that you can afford all these expenses before applying for a mortgage.

Fixed-rate mortgages are the most popular loan type, but they do come with their share of drawbacks. For instance, they may be harder to qualify for than adjustable-rate mortgages and may offer higher interest rates or require a larger down payment.
Adjustable Rate Mortgage

An adjustable rate mortgage, commonly referred to as an ARM, is a home loan with an interest rate that may fluctuate. These loans may be useful when fixed-rate mortgages become difficult due to unpredictable interest rates.

Arms typically feature a low introductory rate, which can help borrowers save money during the early years. However, your mortgage payment may increase after this period ends, so it is important to carefully weigh all options before making a final decision.

When deciding if an ARM is right for you, the first thing to consider are your long-term objectives. An ARM could be ideal if you intend on staying in your home for several years, anticipate an increase in earnings, or the current interest rate on a fixed-rate mortgage is too high given your financial situation.

Most ARMs feature an initial fixed rate period that lasts anywhere from three to seven years. After this, the interest rate on an ARM adjusts at specified intervals according to market conditions, determined by an index and margin.

Most ARMs feature a rate cap, which limits the percentage of interest that can change during each adjustment. This helps protect borrowers from becoming trapped with an unaffordable interest rate that could force them to default on their mortgage.

Another type of cap is known as the “periodic cap,” which limits how much your interest rate can increase between adjustments. This limit usually stands at 2% for five-year fixed rate ARMs, 4% for seven year adjustable-rate mortgages and no higher than 8% on 15 or 30 year fixed rate ARMs or adjustable rate mortgages.

Some ARMs permit borrowers to prepay part of the principal, or capital, without incurring a penalty. Do note that early payments do not reduce interest paid over the life of the loan like with fixed rate mortgages do, however.
Interest Only Mortgage

An interest only mortgage, commonly referred to as an IO mortgage, allows homeowners to reduce their monthly housing expenses by exclusion of the principal portion from payments. Nonetheless, it comes with certain risks and drawbacks that should be taken into consideration before signing on the dotted line.

During the initial period of an IO, borrowers do not make any principal payments at all. Once that period ends, however, they must begin paying both interest and principal on their mortgage.

These loans are typically tailored towards high-income borrowers and intended to assist people in purchasing homes that qualify for jumbo mortgages.

But they may not be the best option for everyone.

The main disadvantage of IOs is that they tend to be more expensive in the long run than conventional mortgages. This is because borrowers often delay making principal payments for several years during an IO phase, leading to significantly higher monthly payments after that.

Additionally, borrowers typically won’t build any equity in their homes during the IO period.

This can be an issue if you plan to sell or refinance your home before the IO phase ends, or need to use the equity for other purposes.

Building equity can be more challenging if you fail to contribute extra towards the principle during the initialization phase.

If you have a steady income and good credit, an IO may be suitable for you. It provides extra cash flow and the chance to save up for larger purchases such as a new car or wedding.

Dallal cautioned against investing in IOs that weren’t properly structured. He noted that some borrowers may be required to make a significant balloon payment at the end of their IO term.

Budgeting can become a major burden for them, particularly if they anticipate an increase in income in the future.

Another potential risk of IOs is that they lack equity, making it harder to refinance when housing prices are declining.

An IO loan is not suitable for those aiming to pay off their mortgage or build equity in their home.
Jumbo Loan

Different mortgages exist, and it’s essential to understand what each one means for you. Knowing your options allows you to determine which is most advantageous for your situation and get on the path toward home ownership sooner rather than later.

Jumbo loans, also referred to as non-conforming mortgages, are larger-value loans than conventional ones and can be used for properties in high-priced markets. Although they usually carry higher interest rates than conforming mortgages and may be harder to qualify for than their conventional counterparts, jumbos do have their advantages too.

Jumbo loans are not government-backed, yet lenders still need to assume some risk with them. That is why they usually come with stricter requirements than conventional loans.

Before being approved for a jumbo mortgage, the lender will assess your credit score, debt-to-income (DTI) ratio and reserves. While exact requirements may differ between lenders, most require at least 700 in credit score.

Your Debt To Income Ratio (DTI) is calculated by dividing all debt payments – including monthly mortgage payments – by your income. Some jumbo mortgage lenders require that your DTI remain at or above 36%; however, some will allow up to 43%.

Your chances for a jumbo mortgage loan may be improved by paying your bills on time and keeping credit balances low. Lenders also want to see that you have enough cash reserves to cover any changes in finances.

Another consideration when applying for a jumbo mortgage is the size of your down payment. Lenders vary, but typically require you to make at least 20% equity when purchasing or refinancing a home.

Jumbo mortgages may not be suitable for everyone, but they can be an attractive option if you have a large purchase price and sufficient funds to make a substantial down payment on your home. Oftentimes, these loans feature interest-only features during the initial years which could save you money in the long run.

Jumbo mortgage rates can be competitive, and many lenders provide lower rates than conforming mortgages. Your exact rate will depend on the type of jumbo loan you apply for as well as your credit score. With so many options available, shopping around for the lowest rate may not be necessary.