Once you realize you want to buy a home, next comes one of the most important decisions you will make: what type of mortgage are you going to apply for. Will you take a 30-year loan or a 15-year loan? Will the mortgage be backed by Fannie Mae or Freddie Mac or the FHA? Is a VA loan right for you?
To help you decide, we developed a guide to common mortgage types.
Long-term fixed-rate mortgages are the staple of the American mortgage market. With a fixed rate and a fixed monthly payment, these loans provide the most stable and predictable cost of homeownership.
The most common term for a fixed-rate mortgage is 30 years, but shorter-terms of 20, 15 and even 10 years are also available. A shorter term means a higher monthly payment but much lower overall interest costs. Since a higher monthly payment limits the amount of mortgage a given income can support, most homebuyers decide to spread their monthly payments out over a 30-year term.
Since monthly payments can both rise and fall, ARMs carry risks that fixed-rate loans do not. ARMs are useful for some borrowers -- even first time borrowers -- but do require some additional understanding and diligence on the part of the consumer.
There are both Traditional ARMs and Hybrid ARMs.
Traditional ARMs have interest rates that adjust every year, every three years or every five years. You may hear these referred to as "1/1,” "3/3” or "5/5" ARMs. These refer to how frequently the rate changes and how long the new rate remains. For example, initial interest rate in a 5/5 ARM is fixed for the first five years. After that, the interest rate resets to a new rate every five years until the loan reaches the end of its 30-year term.
Almost a "best of both worlds" product, Hybrid ARMs offer initial fixed interest rate periods of three, five, seven or 10 years; after that, they most frequently turn into a 1-year ARM, where the interest rate will change every year thereafter.