Before you start shopping in earnest for a house, you need a mortgage commitment to prove your legitimate status as a prospective buyer. Before shopping for a mortgage with a financial institution or broker, become familiar with the types and terms of mortgages so you can negotiate wisely. The type and term of your mortgage can be a benefit for you or create future problems, depending on your situation.
Common Mortgage Types
Each type of mortgage comes with its own set of possible payback periods or terms. The fixed mortgage, the most common type, loans principal for a specific term at an interest rate that stays the same throughout the life of the mortgage. Another common form, the adjustable-rate mortgage, or ARM, pegs interest to an “index” -- a percentage determined by U.S Treasury bond rates, Federal Reserve prime rate of lending or other source. Traditional ARMs change annually, but hybrid ARMs, based on longer terms, give more value when indexes are rising.
Fixed-rate mortgages are originated for 15-, 20- or 30-year terms. Shorter terms pay off mortgages faster, but longer terms have lower payments. The total of interest and principal, divided by the number of months -- 180, 240 or 360 -- gives your monthly payment for the entire life of the mortgage. Lenders might also consider writing fixed mortgages for longer terms, but a 40- or 50-year term loan would add too much interest to a principal amount to benefit anyone but the lender. Fixed-rate mortgage terms may be renegotiated if the original loan is refinanced to take advantage of a lower interest rate or for some other reason.
Hybrid ARM payments change as indexes increase or decrease and interest rates rise and fall. They benefit mortgage-holders who buy when rates high. Because the annual percentage rate, or APR, is typically lower than fixed-rate loans, they also benefit homeowners who plan to stay in a house for only a few years. Hybrid ARM loan APRs may re-set every three, five, seven or 10 years. Most ARMS have “caps,” maximum APR increase limits, to protect borrowers. ARM terms, like fixed-rate terms, may reset or change as the result of a refinancing negotiation.
Lending institutions can negotiate other loan types and terms, including interest-only loans, for which interest is “front-loaded” -- paid at the beginning of the loan. Borrowers pay interest only for an initial period -- say, five years -- after which the note becomes due and they must begin paying a fixed amount based on principal plus interest for another 25 years, making a total term of 30 years. The increase in payment from the initial to secondary term can be significant, making the interest-only option a worthwhile choice only for young people with good future professional prospects or highly mobile people who plan to occupy the house just for the initial, interest-only period.
- Bankrate.com: Three Types of Mortgage Loans for Homebuyer
- U.S. Department of Housing and Urban Development: 100 Questions and Answers About Buying A New Home
- Mortgage Calculator: 10 15 30 40 and 50 Year Mortgages: A Comparison
- NASDAQ: Which Mortgage Term Is Best for You?
- The Mortgage Professor: Refinance a Mortgage Without Extending the Term?
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