There are three basic types of house mortgage loans offered by lenders. Understanding these basic mortgage types will help you choose the best option for financing your purchase.
Fixed interest mortgage is the traditional mortgage loan in which the loan is amortized for the entire loan period using a constant pre-decided interest rate. You have to pay equal monthly installments for the loan period. For the first few years, the interest payments are front-loaded and only a small fraction of the principal is paid from these payments.
In a typical thirty year loan, you have to make some 360 odd payments. A good option is to consider a 15 year loan that will involve around 180 payments. A longer term helps in reducing monthly payments, but it increases the overall costs of the loan. Some forty year loans are also available, but are very rare and fifty year loans are more of an imagination that reality.
The second type is adjustable rate mortgage (ARM) in which the interest rate will change every year for the borrower. Initially, the interest rate offered is low and it is later adjusted according to market rates. An ARM is beneficial only when fixed rate being offered in market is very high.
Hybrid mortgage loans, which have features of both adjustable and fixed rate mortgage types are more popular these days. The time period for fixed interest rate varies from three to ten years and after that the loan is subject to annual adjustments in interest rate. You need to understand the index to which your interest rate will be tagged. A margin will be added to index for determining the interest rate for that year. There would be a cap to the adjusted interest rate and the new rate will not exceed that. The cap for initial rate adjustment after a fixed rate period will be more than the cap for latter adjustments. There would also be an overall cap for the entire time period.
The third option is interest-only loans in which you only have to pay only the interest for the first few years. After the first few years, your payments will increase significantly as they will start including the principal payments also. This option is good for you if your income will increase after a few years, but you should avoid it if you are on a tight budget and your income is expected to remain constant.
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