Understanding The Different Types Of Mortgage Loans
As outlined in a recent Chronicles article, mortgage interest rates are at their lowest levels in years. This decrease in rates has led to a surge in new borrowing and caused many current borrowers to refinance higher interest loans. Before taking a new loan or refinancing a current loan, it is important to understand the different types of mortgage loans. This article will discuss the various types of mortgage loans that are available and the advantages and disadvantages of each.
One of the first things most borrowers look at when shopping for a loan is the interest rate. However, the interest rate is but one of many factors to consider. Some loans have a fixed interest rate that remains constant for the life of the loan and others have variable interest rates that change over time.
The most common type of variable rate loan is called an adjustable rate mortgage (ARM). In an ARM, the rate will remain consistent for a time and then adjust at predetermined intervals. When the rate changes, it can either adjust up or down, depending on the economy and interest rates at the time of the change. The most prevalent ARM is called a 5/1. It is so named because the rate remains constant for the first five years, changes on the fifth anniversary, and then changes every year for the life of the loan. There are other ARM’s such as a 3/1 or a 7/1. Adjustable rate loans can be attractive because they often offer a lower initial rate than a fixed-rate loan, but are subject to market fluctuations that can lead to uncertainty and risk. If interest rates are projected to decline, then an ARM may be an attractive option.
Having chosen between a fixed-rate loan or an ARM, the borrower must decide the length of the loan term. The typical mortgage loan is for a 30-year term, but many lenders also offer a 15 or 20-year term loan. The length of the term will affect the monthly payment. Typically, shorter term loans offer lower interest rates. The shorter the term, the higher the monthly payment will be, but the loan will cost less overall because the interest rate will be lower and the borrower will be making fewer payments over time.
Another type of loan is an interest-only loan. Most mortgage loans require the borrower to make monthly payments of principal and interest. However, as the name implies, interest-only loans allow the borrower to make payments of only interest for a period of time. The borrower will then either begin making payments of principal and interest for the remaining term of the loan or they will be required to pay the loan off in full after the interest-only period ends. Loans that require a final lump sum payment are called balloon loans. Interest only loans can be attractive for borrowers that want to minimize payments for a period of time, for example, to carry the property until the borrower can sell or “flip” the property or until they can refinance under a more appealing loan. Interest-only loans, especially balloon loans, can be quite risky if the borrower is unable to sell the property before the interest-only period ends or cannot afford to make the payments of principal and interest after the interest-only period ends.
When considering the various types of loans, the borrower must contemplate the loan’s term, interest rate, and type. The borrow must also focus on the fees and costs that are associated with the loan to determine the best option for their short and long-term goals. It is important to consult legal and financial professionals to ensure that the borrower chooses the best loan for their particular circumstance. Barbosa Legal has a team of experienced attorneys specializing in real estate, commercial transactions, taxation, and estate planning to assist borrowers at all stages of the lending process.