In this second article in our series of mortgage loan types, we're going to talk about the types of loan terms and payments you can choose when you buy a house. Which is best? That all depends on your circumstances. Read up to help determine what works best for you.
Fixed Rate Mortgages- A fixed rate mortgage (FRM) loan is just what it sounds like - your monthly payment and the interest rate you pay when you buy a house is fixed and does not change throughout the life of the loan. In the beginning of the loan term, your payment goes largely toward paying interest. As your equity increases, more of your payment is used toward the principal. Fixed rate mortgages can run from 10 to 40 years. With a fixed rate mortgage, the shorter the length of the loan, the lower the interest rate, and the higher the monthly payment. FRMs are best if you are most comfortable knowing you have a set amount to budget for each month.
Adjustable Rate Mortgages - On the other end of the scale are adjustable or variable mortgage loans. An ARM's interest rate changes in line with any one of a number of indexes including Constant Maturity Treasury (CMT), Treasury Bill (T-Bill), 12-Month Treasury Average (MTA or MAT), Certificate of Deposit Index (CODI), 11th District Cost of Funds Index (COFI),Cost of Savings Index (COSI), London Inter Bank Offering Rates (LIBOR)Certificates of Deposit (CD) Indexes, Bank Prime Loan (Prime Rate)Fannie Mae's Required Net Yield (RNY), and National Average Contract Mortgage Rate. Along with the interest rate, your monthly payments will change as well. To protect you from extreme monthly increases, most of these mortgage loans have an interest rate cap built in that will limit the fluctuation. ARMs can be a good choice if the market is in your favor.
Graduated Payment Mortgages - Graduated payment mortgage (GPM) payments start low and gradually increase. The schedule for the increase is set at the time the loan is granted. There are many GPM payment plans that adjust the rate of the increases with the life of the loan. GPMs with larger overall increases or longer periods of increase start with lower payments at first. The advantage of a GPM is that you can qualify for a larger loan than you might otherwise.
Balloon Loans - A balloon loan is a short-term fixed rate loan with a set monthly payment until the end of the loan. At the end of the loan's term, there is a lump sum payment, or balloon. Balloon loans are usually three, five, or seven years in length. These loans usually have a lower interest rate. Sometimes they will have a refinancing option at the end.