With all the different mortgage types available, trying to understand them for the first time can be like learning a foreign language. Think of this article as one of those translation phrase books - it won't teach you the entire language, but it will tell you enough about what the major types of home loans mean for you to get by.
Here are some mortgage types you are likely to encounter as you start to look into buying a home:
- Fixed Rate mortgage. The word "fixed" here refers to the interest rate on the mortgage. With a fixed rate mortgage, the interest rate you sign on for will stay the same for the entire life of the loan. Key point to understand: If you want a "no surprises" mortgage where the payments won't change over time, a fixed rate mortgage is for you.
- 30-year, 15-year, etc. mortgage. The years refer to the amount of time you have to pay back the loan. There are other mortgage lengths, but these are the most common. Generally, the trade-off is that longer mortgages lower your monthly payments by spreading the repayment period out over a longer time, but have higher rates and cost more over the life of the loan. Key point to understand: if your primary concern is with getting the payment to fit into your budget, a longer loan is probably for you; if you can comfortably afford the monthly payments, a shorter loan should be more cost-effective in the long run.
- Adjustable Rate mortgage (ARM). Mortgage rates vary greatly over time: according to mortgage finance company Freddie Mac, over the past 40 years they've ranged from 3.41 percent to 18.45 percent. Unlike a fixed rate mortgage that locks in a rate over the life of the loan, an ARM allows the rate to adjust periodically based on market conditions. That's helpful to a borrower if rates fall, but can prove costly if rates rise. Key point to understand: An ARM is for you only if you are comfortable with the possibility that your interest rate could rise, making your payments higher (and potentially unaffordable).
- 1-year ARM, 5/1-year ARM, etc. These time periods refer to how frequently an ARM rate can reset. A 1-year ARM could reset every year for the life of a mortgage, while a 5/1-year ARM would hold the initial rate for the first five years, and then adjust every year thereafter. Key point to understand: The more comfortable you are with interest rate fluctuations in your mortgage, the shorter the reset period you can choose.
- Fannie Mae or Freddie Mac mortgage. Fannie Mae and Freddie Mac are independent companies that help finance certain mortgages that meet federally-mandated standards. They do not issue mortgages themselves, but instead buy loans from the private lenders who do. Key point to understand: A Fannie Mae or Freddie Mac mortgage might not offer the bells and whistles that some portfolio lenders do, but they are highly-regulated and among the safest choices you can make.
- FHA mortgage. These loans are made available by private lenders, but backed by the Federal Housing Administration. They are targeted to those who need underwriting flexibility or can't come up with a large down payment. Key point to understand: Getting an FHA loan might limit the terms available to you, but may be your best option if you would not be likely to qualify for a mortgage otherwise.
- VA mortgage.eThese are mortgages made through private lenders, but backed by the Veterans Administration. Their main advantage is that they allow borrowers to finance 100 percent of the property without paying mortgage insurance premiums. Their purpose is to help people who have provided military service qualify for a loan. Key point to understand: These loans are not just limited to war veterans, so if you are on active duty, have provided National Guard or Reserve service, or have lost a spouse in the line of duty, it is worth looking into whether a VA mortgage can help you.
There are endless variations on the above, as well as some more exotic types of home loans. As with a foreign language, after you get the basics of mortgage jargon down, you could spend a lifetime mastering it. Still, as you contemplate the different mortgage types you may encounter, think of it as if you were doing business in a foreign language: stick to what you are sure you understand, and you will be less likely to say or do something unfortunate.