Mortgage

Types of Home Loans

Wheather you're looking to buy a new home or refinance an existing home loan, you're generally going to be dealing with 3 major types of home loans.

  • Adjustable Rate Mortgages (ARM)
  • Combination Rate Mortgage (also known as fixed period ARMS or hybrid loans)
  • Fixed Rate Mortgage

Each of these loans has their advantages. Below I have provided additional information about each type of home loan.

Adjustable Rate Mortgages (ARM)

What goes up, must come down. That's basically the principal of ARMs. The interest rate you pay is adjusted from time to time to keep it in line with changing market rates.

This means when interest rates go up, your monthly home loan payments may go up. And when interest rates go down, your monthly home loan payments may go down.

Now that might sound frightening if you've ever lived in an era when interest rates shot up dramatically, but ARMs have built-in features that reduce the risk of your rate ever going too high.

ARMs are attractive because they offer start rates that are lower than the interest rates of fixed rate home loans. This typically enables you to begin with lower monthly payments and qualify for a larger loan. Reasons an ARM might be for you:

  • You need a lower initial rate to afford to buy the home you want.
  • You are planning to move in a few years and consequently aren't concerned about possible rate increases.

  • You're confident your income will rise enough in the coming years to handle any increase in payments.

How ARMs work:

A start rate, also known as the initial interest rate, gives you a special low monthly payment for a set amount of time (such as 1 year).

After the start rate period is over, your interest rate is based on the performance of a financial index, such as the average interest rate or yield on Treasury bills.

Your loan term dictates how often your payments are adjusted based on the index and how much rates and payments increase at each adjustment. A 6-month ARM adjusts every 6 months. A 1-year ARM adjusts once a year.

At each adjustment, the new rate is computed by adding the margin — a predetermined amount that remains the same for the life of your loan — to your financial index. Example: If the interest rate for the financial index was 5.5% and your margin 2%, then your rate at the time of adjustment would be 7.5%.

Two "caps" may put a limit on the maximum amount your rate can increase. The periodic cap sets the maximum your rate can go up from one adjustment period to the next. The life cap sets the maximum interest rate for the life of the loan.

Some ARMs offer a conversion feature that allows you to convert to a fixed rate loan at certain times during your loan.

Combination Rate Mortgage

If you're worried by the thought of your payment going up in 6 months or a year, or know exactly when you'll be ready to move to a new home, you might want to look into an ARM that protects you against the possibility of rapid interest rate increases for a set number of years.

A fixed period ARM starts with a lower rate than standard fixed rate loans. Your rate then stays the same for the first 3, 5, 7, or 10 years, depending on the fixed period ARM you choose. At the end of that period, your interest rate adjusts every year like a regular ARM according to a financial index (that's why some lenders call them 3/1, 5/1, 7/1 and 10/1 ARMs).

Fixed period loans work for people who:

  • Expect to gradually increase their income and want a few years at a set payment level before potentially paying more.
  • Plan to be in a home for a short time.
  • Intend to refinance before the adjustment period begins.

Fixed Rate Home Loans

Some people just like certainty in their life. Although you can't count on the weather, you can count on a fixed rate home loan. It will have the same interest rate for the entire life of your loan. You may choose from a variety of repayment terms, with 15, 20 and 30 years being the most common.

Fixed rates are a good choice if:

  • You plan to stay in your house a long time. 
  • You like the new rate and want to keep it for the life of your loan.
  • You prefer the security of a fixed principal/interest payment over one that changes periodically.

Government Loans

The Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA) offer government-insured loans. These loans have features that make them easier for first-time home buyers to obtain. To get an FHA or VA loan, you apply through an approved lender.

FHA Loan Features:

  • Low down payment (usually 3% of the FHA appraisal value or the purchase price, whichever is lower)

  • No maximum income/earning limitations.

  • Fixed rate and ARM loans available.

  • Insurance from the federal government replaces private mortgage insurance.

  • Maximum loan amounts vary by county. 

VA Loans features:

  • No down payment loans up to $359,650 for qualified veterans.

  • Loans up to $375,000 available for qualified veterans with required down payment.

  • Fixed rate loans only.

  • More flexible qualification guidelines than FHA or conventional loans.

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