Thinking about a Mortgage? Understand the Basics First

There are a variety of different types of mortgages that are available in today’s market, and there’s also a plethora of lenders that you can choose to get your mortgage from. Let’s look at the various types of mortgages and how to decide which one is right for you, as well as what type of lender is best for you.

Fixed Rate Mortgages

A fixed rate mortgage is a standard type of mortgage where the interest rate is based on the prime rate, plus the lender’s points, at the time the mortgage is taken out. This interest rate and the monthly or bi-weekly mortgage payments stay the same throughout the term of the loan. There are a variety of fixed rate mortgage products available, but the basics of this type of mortgage as explained above, remain the same.

Adjustable Rate Mortgages

Adjustable rate mortgages, or ARMs, are another type of mortgage where the interest rate fluctuates and changes at various times within the term of the mortgage. This means that the interest rate and the monthly payment amount will change several times throughout the course of the mortgage. The ARM’s interest rate is originally set at the beginning of the mortgage and then altered based on the current interest rate. This alteration of the interest rate can mean that your mortgage payments are either higher or lower, depending on the difference in interest rates. ARMs also have a ‘payment cap’, which means that no matter how high the interest rate goes, your mortgage payment will never exceed the cap. However, if your payment would exceed the cap, you are paying much less on the principal of your mortgage as you pay off the increased interest.

Deciding between an ARM and a Fixed Rate Mortgage

The choice between an ARM and a fixed rate mortgage is one that depends a lot on the current interest rates. If the interest rates are high, an ARM will provide relief from the high rates when the interest rate changes. If interest rates are low, a fixed rate mortgage will protect you from rising interest rates of the future. The decision is a risk because no one can foretell the market perfectly; however in conjunction with your mortgage amount, the amount of your income as well as the length of time you want to live in your home, you can make the appropriate decision for your situation.

Subprime Mortgages

A subprime mortgage is for people with less than perfect credit – generally a credit score under 620. These mortgages have higher interest rates than standard mortgages and are aimed at people who don’t have good credit. If your credit score is blemished, a subprime mortgage is likely the only type of mortgage you’ll be able to get, however you need to watch for predatory lenders who are looking to make money instead of helping you rebuild your credit rating. You’ll have to do some research on the lending company before signing up for a mortgage; make sure they have a solid reputation in the industry.

Other types of mortgages

While ARMs and fixed rate mortgages are the most common and standard types of mortgages that homeowners look for, there are some other types of mortgages that you can choose from: Jumbo mortgage – If you need to borrow more than the single-family limit for mortgages as set by Fannie Mae and Freddie Mac , you need a jumbo mortgage. These mortgages tend to have a higher interest rate. Two-step mortgage – A two-step mortgage combines the fixed and adjustable rate mortgages and tend to go by confusing names such as 2/28, 5/25 or 7/23 – basically you get a fixed rate for the first initial period (2 years, 5 years and 7 years as in the examples above) and then the interest rate is adjusted and remains fixed again for the remainder of the term of the mortgage (28, 25, or 23 years). These are good mortgages for people with less than perfect credit to rebuild their credit thus getting a better rate when the rate adjusts. However, if the borrower doesn’t improve their credit rating, it means they could be stuck with a high rate for the remaining term of their mortgage. Balloon mortgage – A balloon mortgage allows for lower payments and interest rates for a period of time (usually three to 10 years), and at the end of the term, the borrower is required to pay off the remaining funds owed on the house or refinance with a different mortgage. Assumable mortgages – While assumable mortgage are rare, homeowners who have an assumable mortgage can give the loan to a buyer with a down payment instead of paying it off from selling the home. Construction mortgage – For people who want to build a home instead of buying a pre-existing one, a construction mortgage is what they need. Basically it is a two step mortgage where the buyers pay higher interest through the construction phase and have funds to pay the builders. When the home is completed, the loan is turned into a mortgage, which is usually a long-term fixed rate mortgage.

Types of Lenders

There are a variety of lenders to choose from including traditional banks, mortgage brokers, Internet banks/sources, home builders, real estate agencies and mortgage banks. Depending on the type of mortgage you’re looking for as well as the type of borrower you are and your credit rating, the type of lender you need could change. Traditional banks and mortgage banks are for people with good credit histories while mortgage brokers can offer the variety of several different mortgage companies or banks. Mortgage brokers are best for people with a lower credit score because the broker can direct your mortgage application towards the institutions that are most likely to accept your application. A mortgage broker also only is one hit on your credit report and gets you more options for your mortgage, where doing this by yourself could result in blemishing your credit rating.