When it comes to buying a home, you may think that your only option is a 30-year, fixed rate mortgage. But there are plenty of options out there.
Here’s a basic overview of 16 types of mortgages, some common and some less so.
Fixed Rate Mortgage
Fixed rate mortgages are the most popular option because set interest rates mean predictable monthly payments. Currently, shorter loan terms are becoming more popular. USA Today reported in 2011 that 34 percent of refinancers shortened from a 30-year to a 20-year or 15-year loan.
- 30-Year Mortgage: The New York Fed noted that in 2010, the 30-year, fixed-rate mortgage was the most popular option among homeowners. However, as lending standards have changed, many banks prefer to write shorter-term loans.
- 20-Year Mortgage: Like the 30-year mortgage, this fixed-rate option offers consistent payments. You just pay off your house sooner.
- 15-Year Mortgage: You’d think that payments for a 15-year mortgage would be twice as high as payments for a 30-year. But because 15-year mortgages generally have lower interest rates, this isn’t the case. That’s one reason these shorter-term mortgages are becoming more popular.
Adjustable Rate (ARM) Mortgage
As you might guess, the interest rate on an adjustable rate mortgage fluctuates. Exactly how the interest rate changes depends largely on the type of loan you get.
In many areas of the world, including Britain and Australia, adjustable rate mortgages are the norm, though they’re much less common in the U.S. If interest rates are going down, ARMs let homeowners take advantage of that without refinancing, but if interest rates rise, ARMs can result in surprisingly sky-high payments.
- Variable Rate Mortgage: This is just another name for an ARM, but a true variable rate mortgage will have adjusting rates throughout the loan term. Rates normally change to reflect a third party’s index rate, plus the lender’s margin. Mortgage rates will adjust on a set schedule, whether every six months, every year, or on a longer term, and many cap the maximum interest you’ll pay.
- Hybrid ARMs: These adjustable rate mortgages come with an initial fixed rate for a particular period of time. Common hybrids are 3/1, or three years of fixed interest followed by floating interest rates, and 5/1, the same but with a five-year introductory period.
- Option ARM: This type of ARM offers the borrower four monthly payment options to begin with: a set minimum payment, an interest-only payment, a 15-year amortizing payment, or a 30-year amortizing payment. Often, an Option ARM is used to get a borrower a larger loan than he would otherwise qualify for.
Balloon mortgages typically have a short term, often around 10 years. For most of the mortgage term, a balloon mortgage has a very low payment, sometimes interest only. But at the end of the term, the full balance is due immediately. This can be a risky proposition for most borrowers.
Interest-only mortgages give borrowers an option to pay a much lower monthly payment for a certain time, after which they’ll need to begin paying principal. Balloon mortgages are technically a type of interest-only mortgage, though most interest-only options don’t require a lump sum payment of principal.
Instead, these payments will allow the borrower to pay only interest for a set amount of time. After that, the borrower will need to make up for lost time by paying more principal than they would have had they begun with a traditional fixed rate mortgage. In the long term, interest-only mortgages are more expensive, but they can be a decent option for first-time homebuyers or individuals with fluctuating income.
This type of mortgage is for seniors only. A reverse mortgage gives homeowners access to their home’s equity, in a loan that can be withdrawn in a lump sum, with set monthly payments, or as a revolving line of credit. Homeowners don’t have to make payments, but the lender will have a lien on the home for the amount owed upon the death of the borrower(s).
Combination mortgages are helpful for avoiding Private Mortgage Insurance if you can’t put 20 percent down on a home. Usually, you take out one loan for 80 percent of the home’s value and another for 20 percent of the home’s value, or an 80/20 combination loan. Usually the first loan has a lower, fixed interest rate, and the second loan has a higher rate and/or a variable rate.
In an effort to encourage homeownership, the federal government offers some loans that are backed by government entities. This means that if a borrower defaults on the loan, the government will cover the lender’s losses. Because of this guarantee, government-backed loans are often an ideal solution for first-time and low-income homebuyers.
- FHA Loans: These loans are backed by the Federal Housing Administration and are great for first-time homebuyers or those with bad credit. FHA loans can be used for single-family homes, cooperative housing projects, some multifamily homes, and condominiums. The specialized FHA 203(k) loan can also be used to fix up a home in need of significant repairs.
- USDA Loans: The United States Department of Agriculture encourages rural homeownership with specialized, low down payment loans for certain families buying homes in rural areas.
- VA Loans: The Department of Veterans Affairs backs these zero down loans for active duty, reserve, national guard, and veteran members of any branch of the armed forces.
- Indian Home Loan Guarantee: These HUD loans are available to lower-income Native Americans, as well as Native Alaskans and Hawaiians.
- State and Local Programs: If you’re struggling to come up with a down payment or adequate credit score for a home loan, check out state and local government programs. Many programs are geared toward revitalizing particular urban and rural areas, especially where many homes are abandoned or in need of repair.
If you have a home and have some equity built up in it, you can take out a home equity loan, also known as a second mortgage. This is just another loan secured by the equity in your home. Another option is a home equity line of credit, which is a revolving loan based on the equity in your home.