As a home buyer, it is paramount that you learn the different types of mortgage loans to ensure you understand which one is the most suitable for you. If you understand the loans available, and which ones you qualify for, you will be better enabled to maximize long term benefits while minimizing cost. Let’s start talking about loan terminology so you won’t be in the dark when you start house-hunting.
Types of Mortgage Loans
– Fixed Rate Mortgage
The fixed-rate loan gives you an interest rate that will never change for the entirety of the loan. If interest rates increase during the lifetime of the loan, you are safe from any increase of payment on your side.
However, in the same way, if interest rates drop during your loan term, you do not see the benefits of this unless you refinance the mortgage at a lower rate. With a fixed rate loan you have the option to choose how many years you want to take to pay off the loan. These usually end up being terms of 15, 20, or 30 years.
- 30 year fixed rate
- This term gives you maximum tax advantage by having the highest possible interest deduction. The 30 year fixed-rate is usually the easiest loan segment and is the easiest loan term to achieve and be pre-approved for.
- 20 year fixed rate
- Shortening your loan term gets you a lower interest rate. This term is less common so you’ll have to look a lot more carefully for the best lender to serve this specific loan type.
- 15 year fixed rate
- You get the same benefits as the 20 year term here but your monthly payments will be increased since you are paying the loan off quicker than the 20 or 30 year plans. You are out of debt faster and the interest rates are lower. So this is an attractive option if you are able to reasonably make the monthly payments.
– Adjustable Rate Mortgage (ARM)
The adjustable rate mortgage, also known as a variable-rate mortgage or a tracker mortgage, gives you a fixed initial interest rate with a fixed initial monthly payment. After a predetermined amount of time, the initial phase ends and the loan is then subject to changes in market conditions which can either work in your favor or not.
This loan looks attractive at first because the interest rate is usually lower than a fixed rate loan, but you need to determine whether the uncertainty after the initial period is worth it. Market conditions fluctuate but if you feel secure in the outlook of the market as it stands when you are taking out the loan, it might be a good option.
This type of loan is usually the best fit for buyers who only plan to reside in the home for 2 or 3 years. If you can sell the house before the initial fixed rate period ends, you’ll get the benefits of the lower ARM rate and be released from the mortgage before the mortgage is subject to the ever-fickle market. If you plan to stay in the home for the long-term, do not consider the adjustable rate loan. You do not want to be up at night with your heart racing because the interest rate ticked up half a percentage point. Give yourself the peace and reliability of a fixed rate. You relinquish a lot of control by choosing the adjustable-rate mortgage. Understand realistically what your living plans are when you purchase a home: short-term, investment, or lifetime home.
– Balloon Loan
A balloon loan is fixed rate and short term. You can make small payments for a predetermined initial time. After the initial period of about five, seven, or ten years, you commit to refinancing or paying off the rest of the loan with a (balloon) lump sum.
– Government Loans: FHA, VA and RHS Loans
- FHA Loan
- This type of loan is insured by the Federal Housing Administration (FHA) and is available for all qualified home buyers. The size of FHA loans is limited but usually cover most moderately priced homes. FHA loans have the benefit of low down payments – around 3 to 5 percent.
- VA Loan
- A low or zero down payment loan backed by the Department of Veterans Affairs (VA). Because the loan is insured by Veteran Affairs, it is able to offer zero down payment. However, this type of loan is only available to qualified military veterans who have the proper paperwork and a certificate of eligibility from the Department of Veterans Affairs.
- RHS Loans
- The Rural Housing Service (RHS) loan provides low-interest rates with zero down payment. This loan is tailored to low or moderate income households in rural areas or small towns.
Remember to do lots of research on all the mortgage loans available to you before applying for one. Ask lots of questions and take the time to learn all the conditions of the loan you are looking at. Stay involved in the process and you will walk away with the best possible terms!
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