Types of Mortgages

If you are going to buy a home you will most likely need to get a mortgage.  There are different kinds of mortgages available to home buyers. What kind is best for you depends on you and your situation.

Mortgages can be categorized in different ways based on the length of the loan, payment agreements and interest rates.

In this article we are focusing mostly on interest rates.  Based on interest rates, there are three main types of mortgages;

Fixed Rate Mortgages

A Fixed Rate Mortgage pack comes with a constant interest rate that remains the same throughout the loan’s lifespan. It is the most common loan favored by many borrowers. Homeowners appreciate its transparency since they can know what interest and principal payments to expect and can create a budget plan.

Fixed rate mortgages are predictable especially since the initial rate agreement does not change despite interest shifts. That is to say, when interest rates increase; your monthly payment is not affected. The same case applies to reduced interest rates.  With this type of home loan, you can pay off the principle in advance through extra payments. Most importantly, a majority of fixed-rate mortgages do not have pre-payment penalties.

Variable Rate Mortgage

Variable rate mortgages are another type of loan offered by lenders and bankers.  This type of loan generally starts with a lower interest rate and after a fixed time, the rate fluctuates according to the market interest rates, as set by the Reserve Bank. It means the interest rates move up or down with the market.

Variable rates operate on the premise that the interest rate will fluctuate over time with the market, but the monthly payment amount will always remain the same. When interest rates are lower, more of the payment will go towards the principal balance. Likewise, when rates are higher, more of the payment will go towards to the interest. For example, as rates change one month 70 percent of your payment goes towards the balance, and the next month only 67 percent of your payment goes towards the balance.

Adjustable Rate Mortgage (ARM)

The interest rate of an adjustable rate mortgage varies during the entire life of a loan. It is usually termed as a hybrid with fixed and variable-rate components where interest remains constant for a period then begins to reset periodically. Changes can occur yearly or monthly depending on the ARM margin (benchmark).

Also known as the Floating Rate Mortgage, the ARM takes different forms due to its dual nature. It can start out stable at fixed rate during the initial period of the loan (i.e., the first 3 or 5 years) followed by an adjustable rate for the remainder of a loan’s lifespan.

Home buyers benefit from the mortgage’s lower initial rates compared to fixed-rate loans.  This allows some home buyers to make large purchases (big or ideal homes) for less (at least initially) using adjustable rate mortgages. Some home buyers use this type of loan if they know they plan to sell the property in the near future.

The above types of mortgages can benefit individuals with the desire to purchase a home of their own. However, first-time homebuyers usually get fixed-rate mortgages since there are predictable. Other more experienced home buyers, who are more familiar with the loans, may decide to select an adjustable or variable home loan.