Mortgage Types - An Overview
By Sharon Secor,
il-odm.org Staff Writer
If you are considering a real estate purchase, among the first issues that will need to be addressed is financing. A wide variety of mortgage options are available in the financial market today, making it very necessary for consumers to educate themselves on the differences between them in order to secure the best possible loan for their circumstances.
Basic Home Mortgage Categories
Among the most popular home financing options is the traditional fixed rate mortgage, or FRM. This is the loan of choice in nearly 70 percent of home purchase transactions. The characteristic of fixed rate mortgages that makes them most appealing to many consumers is stability. The interest rate of this loan is locked in at origination and remains the same throughout the term of the loan, regardless of changes in the prevailing market rate. This allows the consumer to rely upon a stable monthly payment on the principle and interest throughout the term of the loan, whether it spans 30 years or 15.
Adjustable rate mortgages, or ARMs, are another option that has become quite popular in real estate transactions. These loans have an interest rate that is tied to an index, changing with prevailing market rates. Generally, certain intervals at which the interest rates are adjusted are specified in the loan contract. If the prevailing market rate has increased from one adjustment period to the next, the monthly loan payments will rise. If interest rates have fallen, so too will the consumer’s payment. Often, there are caps placed on the amount that the rate can change during each adjustment period, and some carry a lifetime cap, limiting the amount rates can be increased over the term of the loan.
Under the umbrella of the two main categories of home loans, fixed rate and adjustable, are a number of variations, some of them combining characteristics of both. A few of the most common variations are outlined below.
The FHA loan is a fixed rate mortgage that is designed especially for the first time home buyer of moderate or low income. Guaranteed by the Federal Housing Administration, these loans can be easier to qualify for than a traditional FRM and allow a smaller down payment than most other home loans, generally about 3 percent. Interest rate are usually lower than standard fixed rate loans, and programs are available for the purchase of single family homes or multi family ones, as long as they are to be owner occupied.
VA loans are another government guaranteed mortgage. To be eligible for a VA loan, one must have a history of active military service or be the surviving spouse of an active service member. Often, a veteran can obtain a VA loan with little or no down payment, but must demonstrate the ability to make monthly payments.
The USDA Rural Development Guaranteed Housing Loan is another government guaranteed home loan option. This type of home mortgage loan is provided to low and moderate income individuals who are purchasing a home in an area designated as a Rural Development eligible area. No down payment or mortgage insurance is required with this loan program, and qualification can be much easier than your average home loan, allowing consumers with less than perfect credit to obtain financing for home purchases.
Also referred to as flexible payment ARMs, Option adjustable rate loans have an interest rate that adjusts every month with no adjustment caps. These loans allow borrowers to make very low mortgage payments initially, but these monthly payments will rise over time, often quite steeply.
These are structured with a payment schedule similar to that of a thirty year fixed rate loan, although the term of the balloon loan is shorter, most often spanning five to seven years. At the end of the loan term, the outstanding balance must be paid in one lump sum, either out of pocket or by refinancing the home.
An interest-only mortgage is a loan that allow the borrower to pay only the interest on the loan for a predetermined period of time. The principle of the loan is not paid down during this period at all, leaving the homeowner a lower monthly payment to meet over the short term. However, once this initial interest only period expires the payments increase to include repayment of the principle and are steeper than a standard loan, as the principle must be paid over a shorter time period. The longer the interest only period, the higher the payments will rise after its expiration.
These are loans in which the borrower makes payments every two weeks instead of the typical monthly payment arrangement. The result of this practice is a slightly shorter repayment term. Paying biweekly results in 26 payments a year, which is equivalent to thirteen monthly payments, rather than the twelve payments made with a standard monthly mortgage payment.
Bimonthly mortgage plans do not require any extra payments, but save slightly on interest by advancing the payment by half the month. On average, these types of arrangements only shorten the loan term by approximately one month on a thirty year mortgage.
While each option may prove itself best for a segment of loan seeking consumers, none will be a perfect fit for everyone. Depending upon personal finances, the length of time one intends to reside in the home to be purchased, and many other factors, the perfect home loan option will vary widely from one consumer to another.