Home mortgages come in many different shapes and sizes. They each have different interest rates, terms, fees, etc. depending on your individual credit score. There are several different types of mortgages available to help potential homebuyers combat rising home prices such as fixed rate mortgages, adjustable rate mortgages or ARM mortgages, 80/20 loans, 40 year mortgages and jumbo mortgages.
Adjustable Rate Mortgage (ARM mortgage)
An ARM may be a good choice for you if:
- You plan to live in your home for only a few years
- You want or need lower initial monthly payments and can handle future payment increases (as the home loan interest rate resets)
- You want/need to qualify for a larger mortgage amount and you expect your income will increase over time
Some of the key elements to an ARM mortgage
- You can choose to have your initial interest rate (determined based on individual credit rating and other factors) fixed for a period of time up to 10 years. During the time period you select, your home loan interest rate and monthly payments will remain the same.
- Your interest rate will adjust (usually annually) based on a specific financial index, such as the price of U.S. Treasury bills or securities. Find out from your lender prior to closing so you can closely monitor these changes.
- In addition to the financial index, an additional percentage, referred to as a margin, may be added to the index value to determine your home loan interest rate after adjustment.
- Rates will adjust up and down based on the economy. There is an interest rate cap on most ARMs on the periodic adjustments for the life of the loan so your monthly payment will never increase over a certain amount. This number is also important to find prior to closing.
Fixed Rate Mortgages
Fixed rate mortgages are the most common type of mortgages and are usually offered for 15 or 30 years, although 40-year fixed rate mortgages are becoming increasingly popular. These mortgages allow homeowners the security of knowing what their mortgage payment will be for the life of the loan, from the first payment to the last. The only exception to this is property tax fluctuations.
Some additional options to a fixed rate mortgage include:
- Biweekly mortgage. This allows homeowners to accumulate equity more quickly by making mortgage payments every two weeks.
- Balloon mortgage. These loans offer lower interest rates for shorter term financing, usually for seven years. At the end of the seven years, you are required to either refinance or pay a lump sum.
Forty Year Mortgage
Forty year mortgages are becoming increasingly popular options. This type of fixed rate mortgage allows homeowners to make lower monthly payments by extending the life of the loan without taking on the risk sometimes associated with ARM mortgages. This type of loan is also appealing to buyers with a smaller down payment. It is also sometimes easier to qualify for these mortgages, as well as qualify for a larger loan amount.
80/20 Mortgage
Another option for homebuyers with little or no down payment is the 80/20 mortgage. This mortgage option is ideal for borrowers who need 100 percent financing and often eliminates the need for private mortgage insurance, which is usually required when the loan amount is more than 80 percent of the purchase price.
With this type of mortgage, the homebuyer takes out two loans, one for 80 percent of the purchase price and one for the remaining 20 percent. The second loan usually comes with a slightly higher home loan interest rate, often between one and three percent. However, the combined 80/20 payment is typically less than the cost of a loan of greater than 80 percent of the home's value, plus mortgage insurance, especially if the homeowner is able to itemize their deductions on federal income tax, as mortgage interest is deductible but mortgage insurance is not.
Jumbo Mortgage
A jumbo mortgage is a mortgage with a loan amount above the industry standard, usually more than $400-500,000. The industry standard is set by the two largest secondary market lenders, Fannie Mae and Freddie Mac.
Interest rates on this type of mortgage are typically greater than other loans and will vary depending on the property and actual amount of the loan. These loans also represent a higher risk for lenders.