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What Types of Mortgages Are Available?

There are many underwriting variations on the mortgage theme, and they’re often tough to compare effectively. Interest rates and fees among lenders not only are different but are expressed differently. Lower charges for some aspects may be balanced by higher charges for others. Be sure you are comfortable with your lender.  Be sure they are also large enough to have all of the required options. 

Fixed-Rate Mortgage (FRM)

Fixed-rate mortgages are popular because they’re relatively simple and low- risk. The most common types are 15- and 30-year Fixed Rate Mortgages, although other loan terms are available.

Advantages of a Fixed Rate Mortgage

• Stable monthly payments
• Rising interest rates have no effect on the cost of borrowing
• The opportunity to make extra payments on the principal can significantly reduce the length and cost of the loan
• The mortgage is paid in full by the end of the term

Disadvantages

• Falling interest rates have no effect on the cost of borrowing
• The interest charged is generally a bit higher for Fixed Mortgage Rates, because lenders assume the risk of any gap between your long-term rate and what they could get on a new mortgage in a tight money market
• Penalties for paying off the loan early are often included, sometimes they can be hefty.

Adjustable-Rate Mortgage (ARM)

 Adjustable-rate mortgages are those in which the interest rate is altered periodically during the life of the loan. For most ARMs, the rate is fixed initially, commonly for one, three or five years, and adjusts for the remaining years. ARMs require knowledge and attention on the part of the borrower.

Advantages

• Monthly payments go down if interest rates fall
• Falling interest rates reduce the overall cost of the loan
• The starting rate charged by lenders is generally less than for FRMs, because the borrower assumes the risk of unfavorable changes in the money market which can fluctuate over time.

Disadvantages

• Monthly payments may go up significantly, sometimes leading to default
• Caps on the monthly amount to safeguard the borrower can result in payments lower than the amount due, so the outstanding balance increases every month
• Making extra payments to principal does not shorten the term of the mortgage and is therefore less helpful than with FRMs
• Re-financing to avoid huge hikes may incur pre-payment penalties and may be impossible if the property has insufficient equity

Interest-Only and Negative-Amortization Loans

Payments on interest-only loans cover only the interest on the amount borrowed. The principal does not lessen during the term of the mortgage. Payments on negative-amortization loans cover neither the full amount of the interest nor the principal. Unpaid interest is added to the balance owed, which increases steadily.

Advantages

• Monthly payments are lower
• It is possible to carry a more expensive property than otherwise affordable

Disadvantages

• Equity does not build up in the property
• If the house drops in value from the time of purchase, on selling, the owner must pay the difference between the price received and the amount owed

The type of mortgage that’s right for you depends on your goals of ownership and the amount of risk you like and can afford. An investor planning to flip a property quickly would probably not choose a long-term, fixed-rate mortgage. On the other hand, someone who plans to stay in the house more than five years and is uncomfortable with risk might gravitate towards a Fixed Rate Mortgage, the most popular kind. Your guess about whether interest rates will rise or fall may influence your decision. You should consider that rates rise and fall over time and fluctuations in economic conditions may also affect your job and income.