Before approaching a bank, it is important to be familiar with the types of mortgage loans that exist. Since mortgages come in all shapes and sizes, familiarizing yourself with every option may seem like an impossible task; to ease this process refer to the list below in order to be aware of what available to you.
Fixed vs. Adjustable Mortgage. The former refers to the type of rate you are getting from a bank; in this case the rate is literally fixed, and so it doesn’t change for the lifetime of the mortgage. An adjustable mortgage (also known as an ARM, or a hybrid ARM) has a rate that changes, usually once a year. Written as two numbers, the ARM refers to the amount of years for which the interest rate will remain fixed, after which it will begin to be adjusted with the market for the remaining term of the mortgage. For example, a 5/1 ARM will remain fixed for 5 years while a 10/1 ARM will stay stable for 10 years.
30 Year Fixed vs. 15 Year Fixed. A bank will typically lend money for a 15, or 30 year period (*certain lenders offer 10 and 20 year mortgages). The shorter the time period of your mortgage the higher the monthly payments will be simple because the same amount of money is being paid off over a shorter period of time. While monthly payments of a 15 year mortgage tend to be higher, the result is often a lower interest rate due to the fact that the money is being borrowed for less time.
Conventional (Agency) Mortgage. A conventional mortgage is one that is insured by either FNMA (Fannie Mae), or FHLMC (Freddie Mac), large companies that are partially publically held and partially government –controlled. This insurance, which reduces the bank’s risk in lending money to you, typically results in the lowest rate; in order to be eligible for an agency mortgage a borrower must meet a strict criteria in regards to credit, income, and down payment amount.
Federal Housing Authority (FHA) Mortgage. An FHA mortgage is one that is insured by the government, which allows a borrower a less than perfect credit score and/or a small down payment. FHA charges additional fees (both upfront and monthly) for insuring such loans.
“Portfolio” Mortgage. If you aren’t eligible for a conventional or FHA mortgage, you may find a lender who offers a “portfolio” mortgage, which means the lender has access to money that they can lend without selling the mortgage to Fannie or Freddie or having to insure the mortgage through FHA. “Portfolio” mortgages tend to be the least restrictive, yet have the highest rates.
Fully Amortized Mortgage vs. Interest Only Mortgage. A fully amortized mortgage is one in which the monthly payment includes both the interest and principal amount that has been calculated to fully pay off the mortgage after a certain amount of years (typically 15 or 30, depending on the type of mortgage). On the other hand, an interest only mortgage is when the monthly payments first eliminate the interest accumulated before beginning to decrease the principal amount. The advantage here is that monthly payments tend to be significantly less than the former; banks will usually allow interest only payments for the first several (typically 10) years of the mortgage. After this the banks will require fully amortized payments, which can be significantly higher than the interest only amounts.
A Balloon Mortgage. A balloon mortgage is when the lender specifics that the unpaid balance will have to be repaid in full at a pre-determined point in the future.
A Pre-Payment Penalty Mortgage. A pre-payment penalty mortgage is when a bank imposes a penalty for paying off the mortgage before a particular point in time.
*Balloon and pre-payment penalty mortgages are extremely rare in today’s day and age, and so chances are that you will not come across them.
Now that you are familiar with the options available to you, make sure your decision is informed and realistic. A smart borrower should always be truthful about their current financial situation, as well as where they see their finances going in the future. Remember that, if any questions should arise, there are many people (such as your loan officer) you should feel free to consult with.