When buying a home, choosing a financing option can be a dizzying affair. The variety of mortgages can seem endless. Although there are basically two kinds of mortgages, fixed rate and adjustable rate, the terms of a specific mortgage can vary greatly.
Fixed-rate Mortgages
A fixed-rate mortgage is just that, the interest is unchanged over the life of the loan. This means the monthly payment doesn’t change, regardless of fluctuations in the economy. However, this predictability comes at a cost. The interest rate will be higher than adjustable-rate mortgages, at least at the outset. The lender is assuming some risk for these long-term loans (typically 30 years) because if the prime interest rate climbs you still pay the same amount but the lender will have to eat the difference.
Adjustable-rate Mortgage
Adjustable-rate mortgages (ARM) also begin with a fixed rate, but at the end of this period, the interest rate becomes adjustable and will fluctuate with average interest rates. The initial rate likely will be lower than that of a fixed mortgage but the adjustable period is a gamble because there is no way to predict average interest rates.
One Year ARM – The interest rates fluctuate every year according to the index to which it is tied. The beginning rates are usually very low because of the financial risk associated with them.
10/1 Year ARM and 7/1 Year ARM – The first number, 10 or 7, is the time period during which the mortgage is fixed, after that, the interest fluctuates on an annual basis.
Balloon Mortgage – These are considered high risk because at the end of the loan a large payment for the full loan is due. For example, the borrower might pay a stable interest rate for seven years and then be required to pay off the loan at the end of the term.
Two-step Mortgage – This type of mortgage is like having two consecutive fixed rate mortgages. For the first five or seven years, the interest rate is stable but then in the sixth or eighth year, the rate changes according to the going rate at that time.