There are three major types of home mortgages – fixed-rate mortgages, adjustable rate mortgages and alternative or combination mortgages. Each of these has its benefits and disadvantages along with different types of lending and interest setups within each major type. To learn more about the pros and cons of the different types of home mortgages, keep reading.
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Fixed Rate Mortgage
A fixed rate mortgage is your standard, typical, mortgage. Its main advantage is that your housing costs are predictable – you know how much you can expect to pay every month, when your mortgage will be paid off and exactly how much it will cost you in interest payments.
Typically, a fixed rate mortgage comes in a 30-year term. However, homeowners who are refinancing their homes have increasingly been tapping into shorter 15-year terms, while first time home buyers sometimes consider terms as long as 40 years in order to pay less on their monthly debt.
Another popular type of fixed-rate mortgage is the bi-weekly mortgage. Because making your mortgage payments on a bi-weekly basis allows you to make two extra mortgage payments every year (therefore the equivalent of 13 monthly payments instead of the normal 12), you can pay down your mortgage faster and save tens of thousands of dollars on interest alone.
The major disadvantage of a fixed rate mortgage is that if you get your loan when interest rates are high, you’re locked in at that rate. So, if interest rates fall, you lose out on that potential interest savings and would then need to walk through the steps of refinancing the loan to get a lower rate.
Adjustable Rate Mortgage
Adjustable rate mortgages become very popular when interest rates are high. Typically, lenders offer a low, introductory interest rate followed by an interest rate that’s based on the market average, or slightly above the prime rate. In this scenario, as interest rates rise and fall, so do your mortgage payments.
Bear in mind, though, that the key risk with an adjustable rate mortgage is if the general real estate market rate rises, one’s monthly mortgage payment (on the interest) will rise as well.
If you’re part of a family that expects its income to rise over the years, are only planning to own your home for a short period of time, anticipate stable mortgage interest rates in the foreseeable future, or simply want to get into the housing market but the interest rates are simply too high to lock in with a fixed rate mortgage, than an adjustable rate mortgage is for you.
It is possible to obtain mortgages that change their type as they mature. For example, the Super Seven or Two-Step mortgage gives homeowners a low, predictable interest rate for the first seven or ten years of their mortgage. At that point, their interest is reevaluated based on current market conditions.
The benefit? A lower interest rate to start, particularly if you plan to sell the home within 7 years. The drawback? Depending on rates, your interest rate could jump as high as 6 or 7 percent by the end of your term.
The type of mortgage you ultimately select for the purchase of a home is a weighty decision that must factor in a number of risks and personal circumstances. Before jumping into the excitement of new home – especially for first time buyers – you should talk over options with your spouse, other family members, and those who have some expertise in matters of finance and real estate.