Types of Mortgages

When you are looking for a home, one of the decisions you’ll have to make is about the type of mortgage you want to get. You might think that your biggest decision will be choosing between a 15 year and 30 year mortgage –  but there is a wide variety of mortgage options available. The…
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When you are looking for a home, one of the decisions you’ll have to make is about the type of mortgage you want to get. You might think that your biggest decision will be choosing between a 15 year and 30 year mortgage –  but there is a wide variety of mortgage options available. The good news is you can usually find VA loans to cover most mortgage options.

Types of Mortgages

There are many different types of mortgages, from fixed rate to interest-only to adjustable-rate and balloon mortgages. Here are some advantages and disadvantages of each type of mortgage so you can make a more informed choice for your particular needs.

Fixed-Rate Mortgage (FRM)

The interest rate on a fixed-rate mortgage remains the same for the entire term of the loan. The amount of your monthly payment with an FRM is calculated using the interest rate and its compounding frequency, the term of the mortgage (15 years, 30 years, etc.) and the total amount borrowed. See some of the other factors that affect your mortgage rates, and how to find a low mortgage rate.

The biggest benefit of a fixed-rate mortgage is that you always know how much your monthly payment will be. The only time your fixed-rate mortgage payment fluctuates is if your property taxes and property insurance are handled in escrow and those amounts are adjusted.

The disadvantage of fixed-rate mortgages is that if the interest rates become lower than what you locked into your mortgage, you could end up paying a higher interest rate than you needed to.

Adjustable-Rate Mortgage (ARM)

Interest rates change with adjustable-rate mortgages based on changes in constant-maturity Treasury securities, London Interbank Offered Rate and the Cost of Funds Index. Because the interest rate changes over time, the amount you pay on an ARM can change as well.

An adjustable-rate mortgage helps share some of the rate’s risks with the lender. If the rates decrease, you’ll be able to take advantage of the lower interest rate, whereas, with a fixed-rate mortgage, unless you refinance, you’re stuck with the higher rate you had when you got the loan.

Of course, the disadvantage is if the interest rates increase, you could end up paying much more than you would have if you locked in the rate with a fixed-rate mortgage before the rates increased.

Interest-Only Mortgage

For a specific period of time, borrowers pay just the interest owed on interest-only mortgages. During that period of time, the principal balance doesn’t change. The loan is usually set up with five or ten years of making interest-only payments, followed by amortization of the balance over the remaining life of the loan.

The advantage of an interest-only mortgage is that for the five or ten years that you pay only interest, the payments are substantially lower. It’s ideal for the individual who expects a salary increase by the time the mortgage starts charging principal payments. The disadvantage is you don’t make a dent in the principal for the first few years of the loan.

Balloon Mortgage

Mortgages that are not completely amortized over the term of the mortgage end with a larger balance (the balloon payment) due upon maturity. Balloon mortgages are most often used for commercial real estate and may feature a fixed or floating interest rate.

A balloon mortgage might make sense for people or businesses who plan to sell the property before they reach the large balloon payment; or for those who know they’ll have the money to pay the large payment when it comes due.

The problem with balloon mortgages is that many people reach the end of the term and don’t have the financial resources available to pay for the large balloon payment. Sometimes a “two-step” or “reset” option is used with balloon mortgages, which means the mortgage resets before the balloon payment is due using the current market rates to amortize the remaining balance.

Which Type of Mortgage is Best?

Each of these types of mortgages offers advantages and disadvantages, but in my opinion, the best option is the plain-vanilla, no thrills, fixed-rate mortgage. It may be boring, but right now mortgage rates are near all time lows and locking in low rates for the next 15-30 years is a great way to go. The remaining options have too many variables to be a good option for most individuals.

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About Ryan Guina

Ryan Guina is The Military Wallet's founder. He is a writer, small business owner, and entrepreneur. He served over six years on active duty in the USAF and is a current member of the Illinois Air National Guard.

Ryan started The Military Wallet in 2007 after separating from active duty military service and has been writing about financial, small business, and military benefits topics since then. He also writes about personal finance and investing at Cash Money Life.

Ryan uses Personal Capital to track and manage his finances. Personal Capital is a free software program that allows him to track his net worth, balance his investment portfolio, track his income and expenses, and much more. You can open a free Personal Capital account here.

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