Mortgage is simply a word used to refer to bank loans taken out to purchase a home, yet many Americans view the subject of mortgages as confusing due to the various types of mortgages and the differences between them. Compounding the confusion, the majority of Americans will only go through the process of securing a mortgage once in their lives, and some will never even purchase a home. Every mortgage type can be sorted into one of two main categories, depending on whether interest accrues at one rate for the life of the loan or adjusts over time. Fixed-rate mortgages, in which the interest rate always remains the same, are a popular choice for home purchases, while adjustable-rate mortgages, also known as ARMs, are typically used when a homeowner refinances an existing loan.
Both mortgage types have distinct advantages and disadvantages. With a fixed-rate loan, borrowers have the peace-of-mind that there will be no surprises. Your payments remain exactly the same over time, even if interest rates rise substantially. The disadvantage, meanwhile, is that you will be stuck at the same rate if interest rates drop. With ARMs, however, your initial interest rate might be substantially lower in the beginning of the loan, but that interest rate will adjust based on average rates, so the dollar amount of monthly payments can rise and fall multiple times over the life of the loan. Generally speaking, fixed-rate mortgage products carry longer terms than ARMs, usually 15, 20 or 30 years. Designed to be paid off more quickly, ARMs are normally offered with one or five year terms, though some ARMs are designed to be paid off in 15 years.
Besides being either fixed-rate or adjustable, all home loans are also either conventional or government insured. Conventional loans are those handed out to consumers based solely on their credit qualifications, and are not backed by a government agency. Insured loans might be covered by the Federal Housing Authority or Veterans Administration. The advantage of a government-backed loan is that they’re easier to qualify for, and typically require much smaller down payments than conventional home loans. These borrowers are required to carry mortgage insurance, however, which raises their monthly payments. FHA loans are available to qualified borrowers throughout the general public, while VA loans are only available to active military, veterans and their spouses in some cases.
Another distinction among home loans is conforming or non-conforming, and is based on the actual dollar amount borrowed. Conforming refers to the fact that these loans conform to maximum amount limits set by mortgage giants Fannie Mae and Freddie Mac. Non-conforming loans are also referred to as jumbo loans, in reference to the large amount of money borrowed. Because banks take on considerable more risk with jumbo loans, borrowers usually have to have superb credit histories and come up with massive down payments to qualify, and interest rates are generally higher.
The final type of mortgage is a reverse mortgage, and is unlike any other type of mortgage in that it allows mostly senior homeowners to convert equity into cash to supplement fixed-incomes such as Social Security checks. Proceeds from a reverse mortgage can be paid out in one lump sum, over time in monthly payments, or even as a line of credit. The homeowner is not required to make payments as long as they reside in the house, leaving them more money for monthly expenses. The disadvantage, meanwhile, is that the bank gets the home if the borrower passes away and the estate they leave behind is not enough to cover the balance. The biggest disadvantage to reverse mortgages is that they are often used by predatory lenders, though this can be avoided by making sure the mortgage is federally insured.
Before beginning your search for a new home, you should always take some time to educate yourself on the different types of home loans available in your market. Check with the Better Business Bureau, a real estate agent, and other housing professionals to ensure the lender you choose doesn’t have a history of shady deals. It’s also highly advisable to consult with an attorney before signing any contracts. Different lenders offer different interest rates, mortgage types and quality of service, so it’s a good idea to sit down with several lenders before making your final decision.