Making Sense of Mortgage Options
Trying to assess your options when it comes to mortgage loans can be a challenge. Here is a straightforward guide to the basic types of mortgages.The Big Two
We'll start with the two fundamentals of mortgage loans: fixed-rate loans and adjustable-rate loans. A fixed-rate mortgage is usually considered the least risky type of home loan because your interest rate remains the same for the life of the loan. The most common type of fixed-rate mortgage loan has a 30-year term, but 15- and 20-year terms also exist. An adjustable-rate loan, on the other hand, has an interest rate that is pinned to a market index, which fluctuates with the economy. If you are contemplating an adjustable-rate mortgage, you should first find out what your annual and lifetime interest caps are and how frequently the loan adjusts.
Types of ARMs
Most adjustable-rate mortgage loans come in some hybrid form that borrows some features from a fixed-rate loan. For instance, a typical hybrid ARM might have a fixed rate for a limited initial period ranging from three to ten years. After this term expires, the loan switches to an adjustable rate structure, which usually means higher monthly payments. Another possibility is the Option ARM, which lets borrowers select their mortgage payment from several options each month. The option with the lowest monthly payment usually allows you to pay less than the accrued interest for the month. Of course, any unpaid interest will be tacked onto the balance of the loan, so you will end up paying more in the long run.
Interest-Only Mortgage Loans
You can get an interest-only mortgage loan with a fixed rate or an adjustable rate. With this option, your minimum monthly payment would be only the interest due for that month. This type of mortgage defers payments on the principal until the interest-only period expires, which could be three to ten years from when you take out the loan. There are two serious drawbacks to interest-only mortgage loans. For one, you will not build any home equity unless your property increases in value. Secondly, monthly payments usually explode once the interest-only period is up.
Understand the Trade-Offs
Regardless of what type of mortgage loan you choose, you have to thoroughly understand how your payments and interest rates will change over time, if at all. Remember that if you opt for minimal monthly payments now, you will be sacrificing home equity and facing higher payments down the road. This is a big risk because you can't be certain you'll even be capable of making higher payments in the future.