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Understanding Different
Types of Mortgage Loans
Today's homebuyer has more financing options than have
ever been available before. From traditional mortgages to adjustable-rate
and hybrid loans, there are financing packages designed to meet
the needs of virtually anyone. While the different choices may
seem overwhelming at first, the overall goal is really quite simple:
you want to find a loan that fits both your current financial
situation and your future plans. Though this article discusses
some of the more common loan types, you should spend time talking
with different lenders before deciding on the right loan for your
situation.
Most loans fall into three major categories: fixed-rate,
adjustable-rate, and hybrid loans that combine features of both.
Another type of loan involves a "balloon payment" at
the end of the loan. Certain loans are insured by the U.S. government,
while so-called "conventional" loans are not.
Fixed-rate mortgages
As the name implies, a fixed-rate mortgage carries the same interest
rate for the life of the loan. Traditionally, fixed-rate mortgages
have been the most popular choice among homeowners, because the
fixed monthly payment is easy to plan and budget for, and can
help protect against inflation. Fixed-rate mortgages are most
common in 30-year and 15-year terms, but recently more lenders
have begun offering 20-year and 40-year loans.
Adjustable-rate Mortgages (ARM)
Adjustable-rate mortgages differ from fixed-rate mortgages in
that the interest rate and monthly payment can change over the
life of the loan. This is because the interest rate for an ARM
is tied to an index (such as Treasury Securities) that may rise
or fall over time. In order to protect against dramatic increases
in the rate, ARM loans usually have caps that limit the rate from
rising above a certain amount between adjustments (i.e. no more
than 2 percent a year), as well as a ceiling on how much the rate
can go up during the life of the loan (i.e. no more than 6 percent).
With these protections and low introductory rates, ARM loans have
become the most widely accepted alternative to fixed-rate mortgages.
Hybrid Loans
Hybrid loans combine features of both fixed-rate and
adjustable-rate mortgages. Typically, a hybrid loan may start
with a fixed-rate for a certain length of time, and then later
convert to an adjustable-rate mortgage. However, be sure to check
with your lender and find out how much the rate may increase after
the conversion, as some hybrid loans do not have interest rate
caps for the first adjustment period. Other hybrid loans may start
with a fixed interest rate for several years, and then later change
to another (usually higher) fixed interest rate for the remainder
of the loan term. Lenders frequently charge a lower introductory
interest rate for hybrid loans vs. a traditional fixed-rate mortgage,
which makes hybrid loans attractive to homeowners who desire the
stability of a fixed-rate, but only plan to stay in their properties
for a short time.
Balloon Payment
A balloon payment refers to a loan that has a large, final payment
due at the end of the loan. For example, there are currently fixed-rate
loans which allow homeowners to make payments based on a 30-year
loan, even thought the entire balance of the loan may be due (the
balloon payment) after 7 years. As with some hybrid loans, balloon
loans may be attractive to homeowners who do not plan to stay
in their house more than a short period of time.
FHA and VA Loans
FHA and VA loans U.S. government loan programs such as
those of the Federal Housing Authority (FHA) and Department of
Veterans Affairs (VA) are designed to promote home ownership for
people who might not otherwise be able to qualify for a conventional
loan. Both FHA and VA loans have lower qualifying ratios than
conventional loans, and often require smaller or no down payments.
Bear in mind, however, that FHA and VA loans are not issued by
the government; rather, the loans are made by private lenders
but insured by the U.S. government in case the borrower defaults.
Remember too, that while any U.S. citizen may apply for a FHA
loan, VA loans are only available to veterans or their spouses
and certain government employees.
Conventional Loan
A conventional loan is simply a loan offered by a traditional
private lender. They may be fixed-rate, adjustable, hybrid or
other types. While conventional loans may be harder to qualify
for than government-backed loans, they often require less paperwork
and typically do not have a maximum allowable amount.
As has been discussed, the length of time you plan to own a property
may have a strong influence on the type of loan you choose. For
example, if you plan to stay in a home for 10 years or longer,
a traditional fixed-rate mortgage may be your best bet. But if
you plan on owning a home for a very short period (5 years or
less), then the low introductory rate of an adjustable-rate mortgage
may make the most financial sense. In general, ARMs have the lowest
introductory interest rates, followed by hybrid loans, and then
traditional fixed-rate mortgages.
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