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Mortgage Loans-Your Loan Options  

Your three basic loan options when buying a home are:

  • Fixed-rate mortgage
  • Adjustable rate mortgage
  • Balloon mortgage

Different loans are better for different people depending on their particular circumstances and preferences.

Fixed Rate Mortgage

A fixed rate mortgage has a fixed rate over a specified term (generally 15 or 30 years). This is the most common type of mortgage loan. The loan is the same from beginning to end. The interest rate and monthly payments will be the same at the end of the loan as they were at the beginning if you have not made any changes to the loan. This is also a low risk loan. The only risk you take with this type of mortgage is that the interest rates may drop and you are stuck with the interest rate your loan began with unless you choose to refinance.

Advantages:

Unlike with the adjustable rate mortgage, there is no risk that your monthly payments will increase because the interest rate is fixed for the life of the loan.

There are no changes. Unless you refinance, your mortgage expenses will be the same for the life of the loan making it easier to budget mortgage expenses.

Disadvantages:

Fixed rate mortgages have a higher interest rate. Lenders charge a premium for the security of a fixed rate. They are taking a risk that interest rates will increase and cause their profit on your mortgage to decrease.

Calculator:  What would my payments be for a fixed rate loan?

Adjustable Rate Mortgage (ARM)

An ARM has a fixed rate for a specified number of years at the beginning of the loan, and after that beginning term, the rate may be adjusted annually for the remaining life of the loan. The rate you pay on an ARM is based on a fluctuating index plus a fixed extra amount, called a margin. Keep in mind that different indexes go up and down faster than others and both the index used and the margin can vary among lenders. So compare your choices carefully.

Advantages:

ARMs have a lower initial interest rate. This also means a lower monthly payment. The initial interest rate on an ARM is fixed. The main difference among ARMs is the length of this fixed period. The shorter the initial fixed period, the lower your interest rate will be.

You may be able to borrow more. In general, a greater loan amount may be available with an ARM loan because of the lower initial interest rate.

Disadvantages:

Your interest rate might go up. If interest rates go up, and you stay in the house longer than expected, you may have to face larger monthly payments.

If you plan to be in the house for 5 years and get a loan where the rate is fixed for the first 5 years but you end up holding the mortgage for 10 years, your monthly payments will probably rise after the initial period.

Calculator:  What would my payments be for an adjustable rate loan?

Some Other Important Questions to Ask:

  • Is there a rate cap? Rate caps limit the size of interest rate changes for periodic adjustments and for the life of the loan.
  • When and how often does the rate change?
  • Are you able to change the ARM over to a fixed-rate loan?
  • Is your ARM assumable? If you choose to sell the house, the buyer can take over or "assume" the mortgage.
  • Are there any penalties for paying off your loan early? Being able to prepay your ARM will allow you to refinance if rates go down.

Calculator: Which loan is better, Fixed or Adjustable?

Balloon Mortgage

A balloon mortgage starts out the same as a 30-year fixed rate mortgage, but after the initial term, you have to repay the entire loan balance.

Advantages:

It gives you protection from rate increases for the initial term. The interest rate and monthly payment on a balloon loan stay the same over the initial term, so there is no risk of rate increases./p>

Your initial interest rate is lower than a 30 year fixed loan. The rate is fixed for only three to seven years, so the interest rate won't be as high as on a 15, 20 or 30 year fixed rate mortgage.

Disadvantages:

Your interest rate might go up. If, after three years, you have to refinance the mortgage, your payments will increase if rates have gone up.

You are forced to refinance or sell after the initial term. If the housing market takes a dive, you may not be able to sell the house for as much as you owe on the loan. Most people who get a balloon may have had trouble qualifying for other types of loans, so there is no guarantee on qualifying for a refinance loan.

 

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