There are several different types of mortgage loans commonly made available to borrowers. Some options are more financially conservative than others, and each type will appeal to people under different circumstances. For example, some types of loans are more expensive, but will offer a set monthly payment for the entire life of the loan. In other types of mortgage loans your payments can vary over time.
In a fixed-rate mortgage, the interest rate is set and does not go up or down over the entire life of the loan. A fixed-rate mortgage offers financial security, as the payment never changes. Fixed-rate mortgages are usually available for 15, 20 or 30 year loan periods. The 15 and 20 year mortgages generally have lower interest rates than the 30 year mortgage, but may be more difficult to qualify for.
Adjustable-Rate Mortgage (ARM)
The interest rate changes over time with an adjustable-rate mortgage (ARM), usually in relation to a particular index, such as the interbank loan rate. Most ARMs offer an initial period of fixed interest rates before the rate begins to fluctuate. This initial interest rate can be very low. This type of loan is more risky than a fixed loan, as the amount you pay can rise and fall with interest rates. This makes it difficult to budget over the long term. Some ARMs adjust each year after the initial fixed period, while others adjust every two to three years. This type of loan may suit buyers who plan to build equity quickly and sell the property or refinance when the initial fixed period expires.
In a convertible ARM, the borrower starts with an adjustable rate loan for an initial period. At the end of this initial period, the borrower can chose whether to continue on the adjustable rate or move to a fixed rate loan for the remainder of the loan term. This will generally involve paying an additional conversion fee. The interest rate on this type of loan is usually higher than on standard ARMs, but lower than fixed-rate mortgage loans. Borrowers take a risk during the initial period, but some people like the security of being able to chose later on.
Sometimes called interest-only loans, balloon mortgages have a fixed rate with a short term, such as five or 10 years. During the life of the loan, the borrower pays a very low rate, often only the interest. At the end of the loan period, however, the borrower must pay off the balance of the loan all at once. In this type of mortgage, you often still owe the entire cost of your house at the end of the loan period. This type of loan suits people who want to make very small payments upfront and who plan on refinancing or selling the home by the end of the loan term.
Some government agencies offer mortgage loans to those who qualify. The most common is the Federal Housing Administration (FHA) mortgage. These loans are designed to assist first-time home buyers who may have very limited credit, and feature low closing costs and very low down payments. These loans are usually adjustable only, and interest rates on FHA loans can be high. Veterans Administration loans are available to qualified military veterans, who who must first obtain a certificate of eligibility from the Department of Veterans Affairs. These loans feature no down payment and long terms, which results in low monthly payments. Additionally, the Rural Housing Service offers loans with low interest rates and no down payment to low or moderate income households in rural areas.
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