Understanding Mortgages

The definition of a mortgage is a loan that covers the purchase price of a home minus the down payment.  There is not one type of mortgage loan but many.  It is important for any potential home buyer to understand the different types of mortgages in order to make an informed choice of which is best for them.

Fixed­­-Rate Mortgages

A fixed-rate mortgage loan is a loan with an interest rate that will never change throughout the loan period.  This means that your mortgage payment due each month will never change. Most fixed-rate mortgages are for 10, 15, or 30 years. The advantage of this type of mortgage is that you will never risk your mortgage increasing if interest rates rise.  The disadvantage is that you will continue to pay the same amount even if interest rates decline.  Fixed-rate mortgage loans have a higher interest rate than some other types of loans.

Fixed-rate mortgages are most preferred and most advantageous to buyers who are looking to stay in their home for many years.

Adjustable-Rate Mortgages

An adjustable rate mortgage loan is a loan that has a fixed interest rate for a determined period of time (the introductory period) but after that period of time the interest rate on the loan will rise and fall with the current interest rates.  Most ARMS are for 3, 5, or 7 years.  One advantage of this type of mortgage is that the initial interest rate for the introductory period is lower than some other loans.  The disadvantage of this type of mortgage is that after the introductory period your interest rate can potentially rise if the current market interest rates are higher.  After the introductory period your monthly mortgage payment amounts will change depending on the current interest rates.

It is important to note that while your interest rate can increase after the introductory period of the loan there is a cap as to how much.  A rate cap limits how much of an increase your interest rate can see.  A payment cap limits how much your monthly payments can increase.  Cap amounts will be determined when the loan is granted from the lender.  It is important before you sign the loan papers for an ARM to be sure you have reviewed what the cap limits are and that you are comfortable with them.

An ARM is most preferred and most advantageous to buyers who are not planning to stay in their home for more than a few years.

Balloon Mortgages

A balloon loan has a fixed interest rate that covers the entire length of the loan.  These loans are usually for seven to ten years.  Once the loan period is up the remaining balance on the loan must be paid in full.  The advantage of this type of loan is that the interest rates are very low compared to other types of loans.  The disadvantage is that you have to pay off the entire loan balance at the end of the loan period.  The other option if you cannot pay the entire balance off is to refinance the loan.  This could be risky if interest rates have risen.

Balloon mortgages are best for those who see a big increase in salary or change in lifestyle before the life of the loan is over.

Interest Only Mortgages

An interest only loan is a loan where you pay only the interest for a specified period of time.  This is usually five or ten years.  During this specified period of time none of your monthly payments are put towards the principal of the loan.  When deciding to obtain this type of loan many borrowers will choose to put a substantial down payment towards the principal of the loan.  At the end of the specified period your monthly payments will go completely towards the principal of the loan.  It is important to note that while paying the interest only period of the loan you are not building any equity in your home.

Reverse Mortgages for Senior Citizens

A reverse mortgage loan is a loan that is made against the value of your home that a borrower does not have to pay back for as long as they live in the home.  It is a way for senior citizens to convert the value of their home into cash. 

It is important to note that an applicant must be at least 62 years of age to apply for a federally insured reverse mortgage through HUD.  An applicant must also either own their own home outright or have a low enough balance that it can be paid off at settlement.

The loan for a reverse mortgage does not have to be paid back until that home is no longer your primary residence.  Once the home is no longer your primary residence the amount of the loan and any fees will have to be paid in full. 

Conclusion

There are many different types of mortgage loans out there.  Before deciding which is right for you make sure you have a clear and realistic understanding of where you are financially and where you expect to be in the future.  The type of loan that will be most advantageous to you will be a personal decision based on your current and future financial situations.