Taking out a mortgage to finance a home purchase is a decision worth careful consideration. Since a mortgage is a major financial commitment, proper research on a variety of mortgage types is crucial. You want to get a good value home loan that meets your needs and suits your financial situation.
Below is a brief overview of the different types of mortgage products available when buying a house today. We’ll look at fixed-rate, adjustable-rate, interest-only, government-backed, and jumbo mortgages, to help inform you before decision making.
Mortgage Type 1 – Fixed-Rate Mortgages
A fixed-rate mortgage is a home loan where the interest rate remains the same throughout the tenure of the loan. You agree with the lender upon a specific interest rate and regardless of market fluctuations, the monthly loan repayments aren’t affected.
Pros:
- Monthly repayments are fixed making budgeting and financial forecasting easier. You’re aware of the amount you need to set aside for loan obligations.
- Since the interest rate is fixed, it protects you from rising interest rates.
- A fixed-rate mortgage will fully amortize over the tenure of the loan.
Cons:
- Fixed-rate mortgages tend to have relatively high-interest rates.
- Since you’re locked-in, you miss out when interest rates drop.
- It’s more difficult to qualify for longer-term fixed-rate mortgages.
A fixed-rate mortgage is a viable option if you value predictability and certainty. If you’re on a strict budget and might not be able to afford mortgage payments if interest rates rise, a fixed-rate mortgage can make sense. This is also the case if you plan on living in the home for a long period.
Mortgage Type 2 – Adjustable-Rate Mortgages (ARMs)
An adjustable-rate mortgage (ARM) is a home loan with a variable interest rate. The initial interest rate of an ARM is fixed for a specific period. After this, the interest on your outstanding balance is reset periodically based on an index/benchmark.
The reset can be either monthly or yearly. However, there are caps that limit how much the rates can rise each year or throughout the loan term.
Pros:
- ARMs generally have low initial interest rates, which can save you money.
- Lower monthly repayments allow you to put more down on the principal balance.
- You can benefit when interest rates drop because you aren’t locked in.
Cons:
- ARMs are unpredictable. Monthly payments can increase when market fluctuations cause interest rate hikes.
- Some aspects of ARMs, such as indexes, caps, and margins, can be difficult to fully understand.
ARMs can be a great mortgage option if you’re looking to finance a short-term home purchase. This might be a starter home or a home that you intend to resell. It can also be viable if you can stretch your monthly budget in the event rates rise.
Mortgage Type 3 – Interest-Only Mortgages
An interest-only mortgage is a home loan where you only make the interest payments for a certain period. For most products, it’s typically the first five, seven, or 10 years. Following this period, you can repay the principal in a lump sum or make standard scheduled repayments.
Pros:
- Reduces your monthly payment by excluding the principal for the repayment.
- You can manage your monthly expenses better due to increased cash flow.
- Allows you to defer large home payments.
Cons:
- Paying interest only means you aren’t building up equity in the house.
- Monthly payments increase significantly when shifting to the standard schedule.
An interest-only mortgage can be convenient when you’re cash-strapped currently but expect future cash flow. You can purchase a home without needing a large initial investment. The reduced monthly payments are also budget-friendly.
Mortgage Type 4 – Government-Backed Mortgages
A government-backed mortgage is a home loan that’s secured or backed by a federal government agency. The three types of government-backed mortgages include FHA, USDA, and VA loans. The backing agency guarantees the loan amount, protecting you in case of default.
Pros:
- Government-backed loan programs have less stringent requirements making it easier for homeowners to qualify for a mortgage.
- You can be eligible for multiple loans.
- Typically offer low-interest rates and mortgage insurance costs since they reduce risk to lenders.
- They have low or no down payment requirements.
Cons:
- Some loans can have stricter eligibility requirements.
- VA and USDA loans are only available to a certain group of people.
- Rules on the type of home you can purchase.
A government-backed mortgage is an ideal choice if you have a poor credit record, low to moderate income, or can’t make a large down payment.
Mortgage Type 5 – Jumbo Mortgages
A jumbo mortgage is a large loan used to finance home purchases that exceed the borrowing limits of conventional loans set by the Federal Housing Finance Agency (FHFA).
Jumbo mortgages are used to purchase very expensive homes in competitive markets and have strict borrowing requirements.
Pros:
- Avail more money to buy an expensive home that wouldn’t be financeable with conventional loans.
- Allows you to own a home in desirable markets.
- You can use jumbo mortgages to finance investment properties.
- Aren’t tied to Freddie Mac or Fannie Mae restrictions.
Cons:
- They have strict approval requirements, including perfect credit scores, and a low debt-to-income ratio.
- They require large down payments.
A jumbo mortgage can be a viable choice if you have a large family or for multi-generational families living under one roof. You can also consider it if you wish for a luxurious home in a desirable location. Note that you must have stellar credit and the funds to make a sizable down payment.
Conclusion
Overall, the types of mortgages discussed herein can enable you to purchase the home of your dreams. However, not all of them are created equal. Each mortgage type has its strong points and potential drawbacks.
Before approaching a mortgage lender, it’s crucial to conduct thorough research on each mortgage product to determine if it’s suitable for your specific situation. When choosing a mortgage type, be sure to assess your financial and credit standing, consider the obligations of each mortgage option, and compare expected loan costs and fees.
Once you’ve decided on the best mortgage product to finance your dream home purchase, turn to Kime Realty to help you find the perfect home. Since 1993, this team of trusted and experienced realty specialists has helped thousands of homebuyers purchase prime real estate in and around Southeast Michigan.
Feel free to browse high-quality listings and learn more about best-in-class realty services.
