Explanation Mortgage Types

When applying for a mortgage, especially for the first time, the wide variety of mortgage types can be confusing and even overwhelming. It is important to understand these different types of mortgages and the implications they carry in order to ensure you will be able to meet your obligations as a homeowner in the long term. Some types of mortgages can make this more difficult, with interest rates that can change after a certain amount of time.

The main types of private mortgages presented to homeowners are fixed rate mortgages, adjustable rate mortgages (ARMs) and balloon mortgages. Each has its advantages and disadvantages.

With a fixed rate mortgage, the interest rate remains the same for the full term of the loan. A common time limit for a fixed rate mortgage is forty years, but other terms are available. Interest rates for shorter term fixed rate loans are often lower than for longer-term mortgages. A disadvantage to this type of mortgage is that the interest rates are usually a bit higher than other types, especially for a forty year fixed mortgage. The advantage is that the rate never changes. The mortgage can be paid off early if the borrower chooses.

An ARM is a mortgage whose interest rate varies according to a set formula. As interest rates overall change, the interest rate of the mortgage will change according to the schedule in the loan agreement. ARMs can be acquired at fairly low initial interest rates, but the variable nature of these rates can create monthly payments much higher than the initial rate.

A balloon mortgage sets an initial interest rate for a set period of time, usually three or five years. At the end of that time, the remaining amount due on the loan must be paid. In many cases, you can take out a balloon mortgage, benefit from the low interest rates for the first few years, then refinance. However, if you do not meet the necessary qualification to refinance the loan, the lump sum must be paid. This can produce a significant financial hardship.