What Type of Mortgage is Best for You?

When buying or refinancing a home, choosing the right mortgage is essential.  The type of mortgage that is chosen can help a home owner towards greater financial stability, provide flexibility for life’s unforeseen circumstances, or help to build net worth at a faster rate.  The right mortgage can make owning a home much easier, as well as help improve a home owner’s financial situation, but don’t wait until the time of the loan application to decide which mortgage loan is best suited for your needs.

The number of mortgage loan products available has dwindled in recent years as many of the esoteric loan products, such as sub prime loans and stated income – state assets loans are no longer being marketed.  There are, however, many mortgage choices available and choosing the right one can be overwhelming.  Prospective home loan borrowers should assess their financial situation and the attributes found in each loan type before choosing a type of mortgage, to help determine which mortgage is right based for their financial position. 

Mortgages currently available usually fall into just a few main categories.  The main mortgage loan categories are either fixed rate mortgages, adjustable rate mortgages, or a balloon mortgage.  There are also FHA  mortgages and jumbo mortgages, but these are categories of mortgages which in turn will have fixed rate terms, adjustable rate terms and balloon terms.

Each of these mortgage loans have different features and benefits, making them work well for different financial situations.  There are also many types of individual mortgages within these categories that may involve how the rate changes on an adjustable rate mortgage or the term of the mortgage whether it is fixed, adjustable or a balloon loan.

Fixed rate mortgages are the most common home loan products and become an even larger share of mortgage originations when mortgage rates are low.  A fixed rate mortgage may be right for you if you are on a fixed salary and have a regular budget.  A fixed rate mortgage allows the borrower the security of knowing what their monthly payment will be each month, and this payment does not change.  Fixed rate mortgages can be obtained with a variety of different terms with the 15 year terms and 30 year term being the most common. 

The 30 year fixed rate home loan is by far the most common loan among all mortgage loans.  Borrowers that choose shorter terms on fixed rate loan will build equity faster in their home and generally get a slightly lower mortgage rate.  While it is certainly nice to build equity faster, standard 30 year loans do not have prepayment penalties and the borrower can prepay their loan at anytime either with a little extra every month, with an extra payment annually or a lump sum payment as they see fit and build equity quickly at their own pace.

Adjustable rate mortgages have the disadvantage of having a mortgage rate that may change over time and the advantage of a lower initial mortgage rate.  In a low rate environment many borrowers become concerned that interest rates over the long term have only one direction in which they may go, which is up.  The prospect of higher mortgage rates drives more borrowers to fixed rate loans even if the initial rate is modestly higher on the fixed rate loan.  Of course, should mortgage rates decline, an adjustable rate mortgage may also experience a reduction in rate while fixed rate loans will not. 

Another consideration, often overlooked in comparing an adjustable rate mortgage and a fixed rate mortgage in low interest rate environments, is that the difference between a fixed rate home loan and adjustable rate loan is often quite small.  If interest rates rise it is always advantageous to borrow money at a low fixed interest rate that is subsequently paid back with a monthly payment that has been eroded in value by an increasing rate of inflation.  And when mortgage rates are already relatively low, there is little room for an adjustable rate mortgage to come down any further.

An adjustable rate mortgage may very well still be a choice for those just starting out, who may not be able to afford a big mortgage payment or for those borrowers who know they will be in the home for only a short period of time.  An adjustable rate mortgage allows the borrower to lock in a lower interest rate and low monthly mortgage payment amount for the first year or even few years of the loan.  When the initial low rate expires, the monthly payments and mortgage rate may go up.  Theoretically, by that point the borrower will be able to afford the higher payments, if they are just starting in their careers or will have moved on if they intended to reside in the home for only a short period of time.

Balloon mortgages generally have level payments for a certain number of years and then the remaining balance on the loan is due before the scheduled payments pay the loan off in full.  The initial payment period is based on a longer period of time than the time at which the full balance is due.  For example, balloon mortgage payments are frequently based on a 30 year term even though the full balance will due at the end of shorter term such as 5 years.  Once the level payment period ends and the balloon balance is due, the borrower can refinance, sell the property or otherwise pay off the loan.  The benefit of the balloon loan is a lower mortgage rate.  The difference in rate when mortgage rates are high may be substantial but the difference is often quite modest when rates are low.

Before committing to any type of mortgage, research your options carefully.  The key to making a sound financial decision regarding the choice of a mortgage is to both identify and measure the risks associated with that mortgage and to then determine if the risks worth the reward and even if any risks associated with a bad outcome be tolerated.  But, the borrower would fully understand the risks, rewards and the costs of the home loan before filing out a mortgage loan application.