If you are considering a mortgage loan as a first-time or move-up homebuyer or to refinance an existing mortgage, it is important to understand the different types of mortgage loans available. There are many factors to consider when selecting the best home loan to help you achieve your overall financial goals. Our guide below highlights a few of the most common types of loans and some general benefits and potential risks of each.
Fixed Rate Loan
A fixed rate loan has an interest rate that remains constant for the life of the loan, and are traditionally for 15-years or 30-years. Considered a “safe” mortgage loan, fixed rate loans provide security to a homebuyer since they know what to expect of their loan payment and can plan for the future.
- 30-Year Fixed Rate Mortgage – The traditional 30-year fixed-rate mortgage has a constant interest rate and monthly principal and interest payments that never change. While this loan may be a good choice if you plan to stay in your home for at least 7 years, you may want to consider an adjustable rate mortgage if not.
- 15-Year Fixed Rate Mortgage – This loan is fully amortized over a 15-year period and features constant monthly principal and interest payments. It offers all the advantages of the 30-year loan, plus a lower interest rate—and you’ll own your home twice as fast. The disadvantage, however, is that a 15-year loan does require a higher monthly payment.
Adjustable Rate Mortgages (ARM)
These loans have an interest rate that can change, either upward or downward, at specific periods during the life of the loan. The interest rate is typically tied to a financial index that the lender has no control over. When it comes to ARMs there’s a basic rule to remember…the longer you ask the lender to charge you a specific rate, the more expensive the loan. Also called a variable-rate or floating rate mortgage, ARMs take a number of different forms.
- Annual ARM – The interest rate on this loan is recalculated once per year. Monthly principal and interest payments are adjusted annually at the updated interest rates.
- Monthly ARM – With this loan, the interest rate is recalculated every month. Compared to other options, the rate is usually lower on this ARM because the lender is only committing to a rate for a month at a time.
- Hybrid ARMs – These increasingly popular ARMs—also called 3/1, 5/1 or 7/1—can offer the best of both worlds: lower interest rates (like ARMs) and a fixed payment for a longer period of time than most adjustable rate loans. For example, a “5/1 loan” has a fixed monthly principal and interest payment for the first five years and then turns into a traditional annual adjustable-rate loan, based on then-current rates for the remaining 25 years. It’s a good choice for people who expect to move or refinance before or shortly after the adjustment occurs.