6 Types of Mortgage Loans You Should Know About

In United States buying a house requires a huge mortgage. However, customers face a tough time in deciding which Types of Mortgage Loans should best suit their requirement. 

Most of the time borrowers are not much aware of various options available or the details of these mortgage loans. We would be unfolding the most common types of mortgage loans here.

Types of Mortgage Loans

What is mortgage loan

There are so many mortgage products that sometimes it’s as hard to choose the right one, as to buy your own house. To understand which type of mortgage will suit you best you should consider some of the issues:

— Will you income rise or fall?

— Do you plan to stay in your house for a long-time period?

— Do you expect interest rate to rise or fall?

  • 1. Adjustable Rate Mortgages (ARM)

Most adjustable loans fall in the category of 25 to 30 year. A fixed rate of interest is paid in the initial years of loan which may be of 5 to 7 years. This rate of interest is lower that the interest rate of fixed rate mortgage loan. 

Once the initial time period is over the interest rate may vary as per the market fluctuations. This can both be beneficial or risky for the borrower in comparison to fixed rate mortgage loan. 

Beneficial when the market rate is lower than the fixed rate and risky when market rate rocket shoots in comparison to fixed rate mortgage interest rate.

Adjustable rate mortgages (ARM) are tied to an index which is set by the Federal Reserve. The interest rate changes periodically and according to these payments go up and down.

At each adjustment period the lender adds a margin — a specified number of percentage points. It determines the new interest rate on your mortgage.

If you want to understand how an interest rate can vary, you should ask your lender for a chat of historical rate.

Comparing to fixed rate mortgages, ARMs offer a lower initial rate. In case interest rates remain steady or decrease, over the time they can be less expensive. But your monthly payments can rise according to the rise of interest rates.

If you plan to stay in your house less than three years and believe interest rates to go down — consider adjustable rate mortgages.

  • 2. Option ARMs (flex ARMs)

Option ARMs (flex ARMs) are adjustable rate mortgages with a twist.

Each month you receive a statement with up to four payment options and select the amount to pay each month. If you choose the minimum payment you won’t cover all the interest which will be added to your loan amount.

It means that even though you have made a payment, you could own more on your loan, not less, that when your loan began.

This is what you should avoid. If you have a fluctuating income and won’t be tempted to pay the minimum each month — choose this type of mortgage. 

  • 3. Hybrid Mortgages

They combine the features of fixed and adjustable mortgage rate loans. It means that it starts odd with a stable interest rate for a couple of years and then it converts to ARM. If you plan to sell your house shortly after the fixed term is over you should choose this type of mortgage.

Interest-only and balloon mortgages can be helpful when you are experiencing a temporary financial squeeze. They don’t allow you to build equity in your home and can cause serious strain when the principal comes due. It happens because you pay only interest from five to ten years and principal never goes down.

Special types of mortgages are issued by government for those borrowers who have special circumstances. They are:

1) VA home loans (available for those who have served in the armed forces).

2) FHA-insured loans (guaranteed by the Federal Housing administration).

3) Freddie Mac (some of the mortgage products are available for those who obtain certain professions).

4) Lowdown payment options (available for those who have 20% down payment on a home).

  • 4. Fixed Rate Mortgage Loan

The next Types of Mortgage Loans is fixed rate mortgage.

It’s the best one for you if you plan to stay in your home for several years. In case you want your payments to be regular and an interest rate to be unchangeable, fixed rate mortgage will be the most suitable. It is fully amortizing, which means your payments combine interest and principal in the way that in a specified period of time your loan will be fully paid off.

This is the most common type of mortgage loan in U.S. Borrowers are quite comfortable in repaying the instalments as the interest rate in this case is fixed throughout the term up to a certain limit. 

Financial institutions fix the interest rate in this type of loan at a little higher rate in order to cover their risk for fluctuating increased rate of interest in future. 

The usual term for this type of loan is 10 to 15 years. However, this mortgage loan does not decrease the interest rate in case of low interest rate in market, thus it may be a losing deal for borrowers at times.

  • 5. Government Backed Loan

These loans are insured by the government authorities. The Federal Housing Administration (FHA) guarantees mortgages in order to obtain loan on lower down payment. There is certain amount limit for borrowing but they are sufficient enough for buying a decent home. 

With the FHA backing, financial institutions are more than willing to grant loan, hence it has helped the common man to a great extent in obtaining a modest house.

  • 6. Interest Only Loan

These types of loans are best for people with meagre income as they are saved from paying a hefty amount every month as the instalment. Interest only loan is the mortgage loan in which the borrower only has to pay the interest every month for initial years, this saves him a lot of money every month to put it in some other consecutive use. 

However, the rest of amount is paid when asked for or as per convenience. The darker side to this type of loan is that once you start paying the principal amount the monthly instalment proves to be rocket high, and chances are that you may default, owing to the fact that this option was taken because of borrower’s low paying capacity per month.

Final Words

Above are the major Types of Mortgage Loans. Each of them has their own advantages and disadvantages and they tend to satisfy individual requirements. However most common of them are the fixed rate mortgage loan and the Adjustment rate mortgage loans.

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