Purchasing a home is most likely the biggest purchasing decision that you will ever make. However, deciding to purchase a home is only the very first step in the homebuying process.
After you decide to purchase a home, you must decide what type of mortgage is best for you and your financial situation. However, if you’ve never purchased a home before, admittedly, financing terms can be rather confusing.
When selecting the right home loan, you should consider various factors. Primarily, borrowers should have a basic understanding of how home loan mortgages can be structured.
The three most common types of mortgages are adjustable rate mortgages, fixed-rate home mortgages, and balloon home mortgages, all of which we will discuss below.
Fixed-rate home loans (FRM) are structured so that the interest rate will never change throughout the life of the loan.
These home loans offer the most affordable options for borrowers because they protect from rising interest rates. For example, the borrower is protected for three decades from variations in the market if the fixed-rate loan term is thirty (30) years.
Drawbacks of FRMs are two-fold. You are locked into a higher rate if interest rates go down. And frequently, FRMs bring greater loan costs, because they carry higher risks for the lender.
Specifically, if a loan provider agrees to a 30-year FRM at 5 percent interest, and then interest rates continue to rise, the loan provider is locked into a 5 percent interest for the life of the loan. This equates to less money for the lender in general.
An adjustable-rate mortgage (ARM) is constructed so that the interest rate does not stay the same throughout the life of the loan.
Typically, the initial rate may be set for about five years. After that, the rate may be adjusted either up or down, depending on the existing interest rates and the index to which it is tied. The index is a third-party index and is not controlled by the lending institution.
After the initial rate adjustment, ARMs are generally changed every two years for the remaining length of the loan. Interest rate changes or adjustments are usually capped at about 2 percent. In general, this means that the mortgage can’t be increased by more than 2 percent during the rate change.
Likewise, ARMs frequently come with a maximum interest rate. For example, this means that the highest rate the borrower ever pays is 10 percent above the initial interest rate on the loan if the maximum interest rate is set to 10 percent.
Balloon Home Mortgages
Balloon home mortgages are structured so that there will be a balance at the end of the loan term. For that reason, balloon home mortgages are usually short-term loans of no more than ten years before the loan must be repaid.
Some balloon loans require that the borrower only pays the interest throughout the loan term. Interest-only loans typically come with lower monthly payments. However, at the loan’s maturity, the initial balance will be due completely.
Another type of balloon loan computes payments as if the loan were to be paid in full over 30 years, which likewise decreases the balance due at the end of the loan.
Still, most balloon loans should be refinanced after the loan term ends. However, if the customer anticipates reselling the house at a profit before the balloon payment comes due, balloon loans can be useful.
The type of home mortgage you select depends mainly on whether you plan to stay in your home long-term or short-term.
Additionally, you must consider whether or not you expect your property’s value to appreciate quickly. Keeping your long-term goals and objectives in mind will help you choose the home loan that is ideal for you and your finances.