5-Minute Mortgage Lesson: Types of Mortgage Loans

Whether you’re buying your first house or getting ready to refinance, choosing the right loan product is a vital part of the process. Understanding interest rates and loan programs allows you to make an informed decision about the best way to finance what is likely to be the most valuable investment of your life. Mortgage rates are typically separated into fixed and adjustable rates. Here is a brief overview of each type of mortgage loans, along with potential advantages and disadvantages to help you select the best loan product for your next real estate purchase or refinance.  

Types of Mortgage Loans

Fixed Rate Mortgages

Of all the types of mortgage loans, fixed rate mortgages are simple and easy to understand. Your interest rate remains constant throughout the entire life of the loan, so your monthly payment amount never changes. If rates increase later you don’t have to worry about it, and if they drop below your current rate, you’ll have the opportunity to refinance. In order to take advantage of a lower rate, you’ll submit a new loan application based on the current rates and terms that are available at that time. Your mortgage banker will review the numbers with you to make sure the new loan you’re considering puts you in a better long-term financial situation.
Who it’s good for: A fixed rate loan removes any uncertainty connected to future rate changes,  so it can be ideal if you plan to stay in your home for a long time and/or want to ensure you don’t have to worry about switching to a new loan later if rates are starting to rise.

Adjustable Rate Mortgages

Also known as ARMs, adjustable rate mortgages typically start with a lower rate than a 30-year fixed loan. Your introductory rate lasts for a predetermined period of time; after that, it can then rise or fall depending on the index rate used as the basis for your loan. Your index rate might be the LIBOR, for example, which then has a margin added to it whenever you’re scheduled for a rate change. If the LIBOR is at 2.5% and your margin is 3%, your new interest rate comes to 5.5%.
How frequently your rate can change is specified in your loan terms. For instance, a 7/1 ARM provides a fixed introductory rate for the first seven years, and would then change once each year for the remainder of the loan term. ARM loans do come with a cap, meaning there is a limit on how much your interest rate can change in any given year and over the life of the loan.
There are different margins and rate caps available for various types of mortgage loans, so make sure you discuss this with your mortgage banker and find the right loan for your financial circumstances.
Who it’s good for: An adjustable rate mortgage could be a good fit if you don’t see yourself owning the property for a long period of time, and want to take advantage of lower rates and payments during the time that you’ll live there.
These two types of mortgage loans may interest you. But before choosing between the two, discussed below are the pros and cons that you need to know to come up with the best decision.

Fixed Rate Mortgages Pros and Cons:

Pros:

• Rates and monthly payments don’t change
• Provides protection from unexpected interest rate changes in the market
• Gives the freedom to choose the time period for your loan

Cons:

• Limited repayment options
• No option to redraw
• Exit fees are applicable for early exit of loan

Adjustable Rate Mortgages

Pros:

• Payments for interest rates may be reduced depending on market trends
• Lower introductory rate
• Provides options for unlimited additional repayments

Cons:

• Payments for interest rates have the tendency to rise
• Involves risks particularly in a rising interest rate market
• Quick increase in interest rates would mean higher mortgage repayments for a certain period of time

15-Year versus 30-Year Loan Terms

Your loan term is the length of time you’re scheduled to repay your mortgage, typically lasting either 15 or 30 years. 30-year mortgages are the most common, while a 15-year mortgage has a lower interest rate but higher payments since you are paying off the loan in half the time. By paying off a loan in 15 years, you build equity in the property more quickly and significantly lower the amount of interest paid over the life of the loan.
Ask your mortgage banker questions about the types of mortgage loans and have them help you run a variety of scenarios to determine which loan product can best help you meet your financial goals.
*5 minutes are not nearly enough time to really discuss rates, but we think it’s a good start. Do you want to speak with a mortgage banker about your options? Call us at 415.813.4001 or 310.276.7400 and let’s talk.