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Types of Home Loans
Let's start with the biggest difference between home loans: I'm referring to the differences between fixed-rate loans and adjustable-rate loans. With a fixed-rate mortgage loan, the interest rate never changes, regardless of what the economy does. With adjustable-rate mortgages (ARMs) the interest rate adjusts periodically during the life of the loan. There are pros and cons to both methods.
Of course within these umbrella terms, there are many variations. They can still all be classified as either fixed-rate or adjustable-rate.
Fixed rate Mortgage Loan:
As the name suggests, your monthly mortgage payment does not change.
"Certainty" is the primary benefit of a fixed-rate mortgage loan. You always know what your interest rate will be, no matter what the economy does. The disadvantage is that you'll pay a premium for this predictability, in the form of a higher interest rate.
When a mortgage lender grants a fixed-rate loan for a long period of time (like 30 or 40 years), they take on a certain degree of risk. If the prime interest rate goes up during the life of your loan, you won't have to pay the difference -- the lender will. This is why the lender charges a higher interest rate than with an adjustable-rate mortgage
Adjustable-Rate Mortgage (ARM) Loan:
Most adjustable-rate mortgages start off with a fixed rate for an initial period of time, usually 3, 5 or 7 years. During the introductory period, the interest rate is fixed and will not change. After the introduction period, however, the loan converts to an adjustable-rate.
The interest rate on this type of loan is lower than a traditional fixed-rate mortgage. The downside is that you can never predict the interest rate it will adjust to after the introductory period.
Adjustable-Rate Mortgage Loan Continued-
So in this regard, you can think of the initial lower rate period as a reward for the uncertainty of the adjustable period. You will start off with a lower interest rate than a regular fixed-rate loan, but you have the uncertainty of the adjustment phase. For some buyers this is acceptable - for others its not.
During the adjustable phase of the mortgage, your monthly payments will rise and fall with average interest rates. It would be great if they fell, but bad if they rose. All other things being equal, the adjustable nature of the loan is something of a gamble.
A qualified loan officer can help you make an educated decision about the type of home loan that may be right for you.
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