Types of Mortgages

House and Military Couple Framing Hands in Front Yard.

“There is a different loan for a different need.” In other words, the type of mortgage you get depends on your individual situation. A good lender will get a sense of your needs from your credit report, your assets, and your employment history. He can then recommend some options for you. Here’s a rundown on the most common loan types.

Interest is fixed for an amount of time; e.g., 10, 15, 20, 30, or even 40 or 50 years, at which point the amortized principal is paid in full.
Pros: Security. You know what your payments will be. You can refinance if rates drop significantly.

Cons: If rates go down, you’ll still be paying the initial rate unless you refinance.

Watch out: This is a long-term prospect; if you are keeping your home for 15 or even 30 years, it’s a conservative way to go. But you can end up paying more short-term than if you had an ARM.

The interest rate fluctuates with an indexed rate plus a set margin; adjustment intervals are predetermined. Minimum and maximum rate caps limit the size of the adjustment.
Pros: Initial rates are lower than fixed. Popular with those who aren’t expecting to stay in a home for long, or in a hot market where houses appreciate quickly, or for those expecting to refinance. You can qualify for a higher loan amount with an ARM (due to the lower initial interest rate). Annual ARMs have historically outperformed fixed rate loans.

Cons: Always assume that the rates will increase after the adjustment period on an ARM. You are betting that you’ll save enough initially to offset the future rate increase.

Watch out: Check out the frequency of the adjustments. The more often, the lower the starting rate, but the more uncertainty. The less often, the higher the rate, but a little more security. Check the payments at the upper limit of your cap (your rate can increase by as much as 6 percent!); you can get burned if you can’t afford the highest possible rate. And planning that a refinance will bail you out is risky; what if you can’t afford (or can’t qualify) when the time comes?

The interest rate fluctuates with an indexed rate plus a set margin; adjustment intervals are predetermined. Minimum and maximum rate caps limit the size of the adjustment.
Pros: Initial rates are lower than fixed. Popular with those who aren’t expecting to stay in a home for long, or in a hot market where houses appreciate quickly, or for those expecting to refinance. You can qualify for a higher loan amount with an ARM (due to the lower initial interest rate). Annual ARMs have historically outperformed fixed rate loans.

Cons: Always assume that the rates will increase after the adjustment period on an ARM. You are betting that you’ll save enough initially to offset the future rate increase.

A zero-down loan offered to veterans only; the VA guarantees the loan for lenders.

Pros: Nothing down, and no mortgage insurance. The loan is assumable.

Cons: The rate might be higher than conventional loans or FHA loans.

Watch out: Shop around first. Lenders are paid a 2 percent service fee by the government, so your points should reflect a discount when compared to similar rate loans.

Federal Housing Administration Loans (FHA)
Government-subsidized loan with low down payment (i.e., 3.5 % of the sales price) and closing fees included; the government guarantees the loan.

Pros: Low rates for those who can’t come up with the down payment or have less-than-perfect credit; great for first-time home-buyers. The loan is assumable.

Cons: If you can afford 5 percent down, you might find better rates with conventional loans

Watch out: Shop around first. Lenders are paid a 2 percent service fee by the government, so your points should reflect a discount when compared to similar rate loans.

Conventional loan advantages
◾Mortgage insurance is required for loans exceeding 80 percent loan-to-value (Mortgage insurance is required on all FHA loans regardless of the loan-to-value)
◾Conventional mortgage insurance is only monthly or single premium (FHA is upfront and monthly premiums)
◾Conventional mortgage insurance will automatically end at 78 percent loan-to-value (FHA will stay for the entire life of the loan)
◾Conventional mortgage insurance is credit sensitive (For FHA, one premium fits all)
◾Conventional loans can cover much higher loan amounts (FHA over county limits)
◾Conventional loans cover more types of loans (FHA doesn’t do investment or second homes)
◾Even though conventional loans may have higher interest rates, their monthly payments may still be lower