“Huzzah, options! Um, what are they?”
Everyone loves options. The three main mortgage types you’ll frequently encounter while slogging through the house-hunting marathon are fixed rate, adjustable rate, and balloon mortgage loans.
Fixed rate Mortgage: It’s the most commonly used mortgage type and the name says it all- the interest rate on your mortgage remains fixed throughout the entire duration of the loan.
Fixed rates for the time-period of loan
Stability helps budgeting = easier meeting your monthly financial challenges
Easier to understand & prepare for = best option for many first-time buyers
Can’t take advantage of any falling interest rates that may occur
More expensive than adjustable rate mortgages
Adjustable rate mortgage loans (ARM): A loan that is adjusted according to interest rate fluctuations. Because ARM’s have a higher risk factor, make sure you have some savings (you’ve hopefully stocked that emergency fund) that could support the change in your monthly payments if interest rates rise.
Fixed at lower rate for a few years, then resets based on market rates
Interest rates fall = borrower benefits
Lower initial monthly payments are easier to handle
Rates can increase substantially later
Can be more difficult to understand for novice homebuyers
Fluctuating rates can lead to financial distress if buyers don’t have enough in savings
Balloon Mortgages: A short-term loan that doesn’t amortize- the process where you pay off a chunk of your interest first before your mortgage payments start paying down your principal. Here, your regularly monthly payments are primarily interest and your principal is paid off at the end of your loan term, usually five to seven years. It’s not as common as fixed or ARMs for first-time buyers.
Lower interest rates
Lower monthly payments, similar to 30-year mortgage
Good for borrowers who can sell home before mortgage due date, or who expect a generous amount of cash before the end of the loan
Requires a significant lump payment at the end of your mortgage term
If house can’t be sold and principal can’t be paid off, buyers forced to refinance
If interest rates rise, buyer may have new, unfavorable mortgage terms.
You’ll understand almost immediately which mortgage type would work best for your situation if you have a strong grip on your finances. You’ve done your balance sheet exercise, right?
This article is 2nd in the Mortgage 101 Series