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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 mortgages are the most popular option. Set interest rates mean predictable monthly payments. These payments are spread over the length of a term, which ranges from 15 to 30 years, typically. Currently, shorter loan terms are becoming more popular. Back in 2011, USA Today noted that 34 percent of refinancers shortened from a 30-year to a 20-year or 15-year loan.
Generally, the shorter your loan’s term, the lower the interest rate. Lenders take on less risk with a shorter loan term. This means you’ll pay much less interest over the life of a 15-year mortgage versus a 30-year mortgage.
- 30-Year Mortgage: Freddie Mac notes that about 90 percent of homebuyers in 2016 chose the typical 30-year, fixed-rate mortgage. The longer term makes payments much more affordable, which can help home buyers get into a more comfortable payment or a more expensive home.
- 20-Year Mortgage: Like the 30-year mortgage, this fixed-rate option offers consistent payments. You just pay off your house sooner. Some consumers like to split the difference between the longer and shorter terms. The 20-year mortgage will typically have a slightly lower interest rate than a 30-year mortgage.
- 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.
Resource – Start comparing mortgage rates with Reali.
Adjustable-Rate (ARM) Mortgage
As you might guess, the interest rate on an adjustable-rate mortgage fluctuates. Exactly how the interest rate changes depend 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. If interest rates rise, however, 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. But 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 who are starting businesses or careers with only a little money at first.
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).
With a reverse mortgage, you’re fine until you have to move out of the house. If you move out, even if it’s before your death, you’ll need to repay the mortgage out of the proceeds of the loan. This can drain the equity many seniors depend on to fund long-term care expenses. In some situations, a reverse mortgage can be a reasonable choice. Just be sure you know what you’re getting into.
Combination mortgages are helpful for avoiding Private Mortgage Insurance (PMI) 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. This is an 80/20 combination loan. Usually, the first loan has a lower, fixed interest rate. The second loan has a higher rate and/or a variable rate.
This can sometimes be more expensive interest-wise. But do the math. PMI can be expensive, as well. If you can pay off the higher-rate 20 percent equity loan quickly, you may come out better off with a combination mortgage.
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 home buyers.
- 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 areas 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. This is a revolving loan based on the equity in your home.
These loans will typically have a higher interest rate than your first mortgage. But they can be a good option for funding home renovations or other necessary expenses, especially in such a low-interest-rate environment.
The type of mortgage is an important consideration. The good news is you have far more options than many realize. In all cases, focus on the interest rate and fees while you compare rates.