types of mortgages
There are many types of mortgages. The most common ones are:
The 30-year fixed rate mortgage
The 15-year fixed rate mortgage
1 year adjustable rate mortgage
3 year adjustable rate mortgage
5 year adjustable rate mortgage
5 year balloon mortgage
7 year balloon mortgage
You will also find some variations of these common types, such as 20-year fixed rate mortgages, 3-1, 5-1 and 7-1 adjustable rate mortgages.
The fixed rate mortgages are the best when the rates are at historic lows. With a fixed rate mortgage, you pay a fixed percentage interest rate for the life of the loan. You want to lock in a low rate for the years to come and have the comfort of knowing that your mortgage payments will not change from year to year.
The 15 year fixed rate mortgages will tend to have an interest rate that is ½ percent lower than the 30- year fixed rate mortgages, but they are much harder to qualify for (see qualifying information below).
The interest rates for fixed rate mortgages are usually the highest because of the greater "risk margin". If rates rise considerably the lender can be stuck a long time with a mortgage they are losing money on.
If mortgage rates are at historic highs, your best bet is probably an adjustable rate mortgage. With an adjustable rate mortgage, you pay according to an interest rate that changes from time to time. You can expect to get a better initial interest rate on an adjustable than on the fixed rate mortgages, because the adjustable rate mortgages have a lower "risk margin", plus you can ride the rates down without having to incur the expense of refinancing. Adjustable rate mortgages are often offered at a "teaser" rate during the first period of the loan, prior to the first adjustment. Don’t think this is some free lunch or gift of gratitude from the lender. These loans usually come with points that more than make up for the "teaser" discount. One of the real reasons for the teaser rate is to allow one to qualify for a larger mortgage. During economic times when too many of these mortgages are going into default, expect lenders to use the projected cost of the loan in it’s second year to determine the amount of loan you are qualified to take.
The most popular adjustable rate mortgage is the 1-year adjustable, know in the industry as the 1-year ARM. The interest you pay the first year is often a low "teaser" rate. At the end of the first year, the rate is adjusted to become that of some index (typically the 11th District Cost of Funds index or the rate on 1-year U.S. Treasury Bills) plus a margin (some current examples are 2.5% on the COF basis or 2.75% on the 1-year T-Bill basis). Most of these ARMs have an annual maximum amount they are allowed to change, either up or down, (an example is 1% on the COF and 2% on T-Bill basis) and a life of the loan limit as well (an example is 11% on the COF and 5% above the starting rate on a T-Bill basis loan).
The 3 and 5-year adjustable rate mortgages adjust less frequently. Therefore they will have a higher rate because of a greater "risk margin".
Balloon mortgages are mortgages that are based on a fixed rate for the specified period of time. These rates are often lower than the fixed rate mortgages because of a lower risk margin for the lender. At the end of the fixed rate period, the mortgage becomes due. You can generally continue the mortgage beyond the balloon period at whatever the current interest rates are at that time. But be careful. Read the fine print. The balloon mortgage may disallow continuation if you have taken a second mortgage on the property or if you are considered less than a good credit risk at time the balloon expires. Balloon mortgages can be attractive if you expect to move within the balloon period, especially during economic times when other mortgage rates are high.
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