Types of Mortgages
Fixed-Rate Mortgages
Adjustable-Rate Mortgages
The Convertible ARM
Balloon Mortgages
FHA and VA Loans
Since some mortgage options are less conservative than others, it's important to
determine if you are a risk-taker or if you prefer more stability in your financial
dealings. Do you invest in the stock market? Or put your money into Certificates of
Deposit? These are two different ways of handling money. Depending on your answers
to these and other questions that may be asked by your lender, you will be able to
choose the mortgage that is right for you.
Fixed-Rate Mortgages
If you're looking for a mortgage with payments that will remain essentially
unchanged over its term, or if you plan to stay in your new home for a long time, a
fixed-rate mortgage is probably right for you.
With a fixed-rate mortgage, the interest rate you pay and the monthly principal
and interest payments are agreed upon from the outset and will not
change throughout the term of the mortgage. In other words, the interest
rate you close with won't change — and your payments of principal and
interest will remain the same each month — until the mortgage is paid off.
As you can see, the fixed-rate mortgage is an extremely stable choice. You are
protected from rising interest rates. And it makes budgeting for the future very
easy.
But in certain types of economies, interest rates for a fixed-rate mortgage can be
considerably higher than the initial interest rate of other mortgage options. That
is the one disadvantage of a fixed-rate mortgage. Once your rate is set, it does
not change and falling interest rates will not affect what you pay. However, you do
have the option of refinancing if interest rates drop significantly.
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Adjustable-Rate Mortgages (ARMs)
An adjustable-rate mortgage (ARM) is considerably different from a fixed-rate
mortgage. It's best if you're buying a home while interest rates are high, if you
expect increases in your income, or if you don't plan to keep your home long. Keep
in mind, with an ARM, you are taking the risk on the rise or fall of interest
rates, not the bank.
In most cases, the initial interest rate of an ARM is lower than a fixed-rate
mortgage.
With an ARM, your mortgage rate rises and falls with interest rates. Each lender's
interest rates are usually tied to a specific index like COFI, LIBOR, the T-Bill
rate, or the CD index. The rate you pay will be based on your lender's index plus a
margin, usually two to three points. Ask your lender for specifics.
Also ask how the "caps" on your ARM work. "Caps" will limit the
amount your lender can increase your interest rate in a single year and over the
entire term of the loan.
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The Convertible ARM
The convertible ARM is an option that is currently very popular. It's a combination
of both fixed-rate and adjustable-rate mortgages, offering the best of both options
in one package.
The convertible ARM allows you to convert to a fixed-rate mortgage after a set
period of time. For instance, you could get a one-year ARM with the option to
convert any time after the first through the fifth adjustment period. This way you
can initially benefit from the lower interest rate of a standard ARM, then take
advantage of locked-in payments later.
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Balloon Mortgages
Another type of mortgage that has become popular in recent years is the balloon
mortgage, so-called because it requires you to pay off your loan in full or
refinance at the end of the mortgage term (usually five or seven years). The
advantage of a balloon mortgage is that your monthly payments during the mortgage
term are generally lower than they would be for a traditional 30-year fixed-rate
mortgage.
Balloon mortgages are traditionally popular with first-time home buyers with
growing families and with individuals who expect to be relocated by the employer.
If you anticipate moving in five to seven years, you can take advantage of lower
interest rates (sometimes from three-eighths to three-quarters of a percentage
point less than traditional fixed-rate loans) for that time period. If you end up
staying longer in your residence then you'll have to pay the balance at the end of
the term, or more likely, refinance your mortgage at the then current interest
rate. Many lenders also offer an option that allows you to convert to a fixed-rate
mortgage, provided certain conditions are met.
Qualifications for a balloon mortgage vary depending on the lender you choose, but
most require at least a 20% down payment.
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FHA and VA Loans (also known as Government Loans)
Veterans may qualify for Veterans Administration mortgages. There are caps on the
size of a VA loan you can get, but this loan could be ideal for buying a lower
priced home with a small down payment.
FHA or Federal Housing Administration loans are available to Americans with smaller
incomes who are buying modestly priced homes. Look for properties that are
designated as "FHA approved."
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You should consult your tax advisor or attorney for more information on which
mortgage products may be appropriate for you.
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