Common Mortgage Types
Fixed Rate Mortgages
The traditional fixed-rate mortgage is the most common type of home loan. Your monthly payments include both principal and interest payments and do not change over the term of the loan. Fixed rate mortgages are available in terms typically ranging from 10 to 30 years and can be paid off at any time without penalty. This type of home loan is designed so that it will be paid off at the end of the loan term.
Even with a fixed rate mortgage, your monthly payment can change if you have an escrow account. An escrow account is set up with your lender. In addition to the monthly interest and principal payment, the lender will collect additional money each month for your property taxes and homeowners’ insurance, and then pay them when they are due. If either the property tax or the insurance premium changes, the monthly payment will be adjusted.
There are many types of lender programs that use the fixed rate loan including the VA, FHA, USDA and conventional.
Adjustable Rate Mortgages
Adjustable-rate mortgages include interest payments which shift during the loan’s term, depending on current market conditions. Typically, these loans carry a fixed-interest rate for a set period before adjusting. The initial rate on an ARM is typically lower than on a fixed rate mortgage. This can help you afford the purchase of a more expensive home.
Adjustable rate mortgages are usually amortized over a period of 30 years with the initial rate being fixed for anywhere from 1 month to 10 years. All ARM loans have a "margin" and an "index." Margins on loans typically range from 1.75% to 3.5% depending on the index and the loan to value ratio on the property. The index is the financial instrument that the ARM loan is tied to such as: 1-Year US Treasury Bond, Prime or the 6-Month CD
When the time comes for the ARM to adjust, the margin will be added to the index to arrive at the new interest rate. That rate will then be fixed for the next adjustment period. These adjustments can occur every year, but there are factors limiting how much the rates can adjust. These factors are called "caps".
There are many types of lender programs that use the fixed rate loan including the VA, FHA and conventional.
Hybrid ARM mortgages combine features of both fixed-rate and adjustable rate mortgages and are also known as fixed-period ARMs. A hybrid loan starts out with an interest rate that is fixed for a period of years (usually 3, 5, 7 or 10). Then, the loan converts to an ARM for a set number of years. An example would be a 30-year hybrid with a fixed rate for seven years and an adjustable rate for 23 years. The advantage of a fixed-period ARM is that the initial interest rate for the fixed period is lower than the rate would be on a mortgage that's fixed for 30 years, sometimes significantly. This allows the borrower to enjoy a lower rate while having period of stability for your payments.
Interest Only Mortgages
Interest only mortgages are home loans in which borrowers make monthly payments solely toward the interest accruing on the loan, not the principle. Interest Only loans are can be either a fixed or adjustable rate mortgage.
Some interest only mortgages convert to a fully amortized loan at the end of the interest only period. You will have lower initial payments, but they can go up significantly after the initial period.