From rookies to seasoned veterans, we can all agree on one thing – buying a house is expensive. Most of us don’t have the savings capable of handling the entire purchase, so we borrow money. We get a mortgage.
These loan products can be quite daunting, but knowing the basics of how mortgages work can help guide you to the loan that is most appropriate for you.
Types of Mortgages
- Fixed Rate Mortgages (15- or 30-year term)
- Interest rate that remains constant over the life of the loan
- This stability makes them the most secure type of mortgage for buyers
- Interest rates tend to be higher than for other loan types
- Adjustable Rate Mortgages (ARMs) (5- or 7-year term, but
can be as short as 1 year)
- Have a period of fixed interest that resets based on current interest rates
- Tend to have lower initial rates and therefore lower monthly payments
- Can be a good option if money is tight early on, as long as you are confident you can meet future interest and payment increases or are willing to pay the costs to refinance again
- After fixed period ends, the payment changes with whatever index the loan is based on highly sensitive to interest rate changes
- Three types of caps (a safeguard that limits how much your monthly payment can change) that may apply to an ARM:
- Overall cap limits how much the interest rate can increase over the life of the loan
- Periodic cap limits the amount the interest can increase from one period to the next
- Payment cap limits the amount the monthly payment can increase at each adjustment
- Interest Only Mortgages (pay only interest for
a fixed period)
- Pay just interest for three to ten years before payment includes principal and interest
- Qualification can be easier and the monthly costs can be lower than other mortgage types
- Can be a gamble; an interest rate hike could put your payments out of reach
Certainly there are benefits and drawbacks to each mortgage type. Long before you borrow, consider each option carefully to know which is most appropriate for your situation. With so much money at stake, making the best mortgage decision is important.
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