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It pays to learn about the different types of mortgage loans, and to shop around for the best deals, because mortgage lenders tend to offer the best terms to well informed customers who negotiate hard.
An Adjustable Rate Mortgage (ARM) has a variable mortgage interest rate that is reset periodically by adding a margin to an index like the Constant Maturity Treasury index. Margins may differ from lender to lender, and it is worth taking time to look for the best deals.
An ARM may offer a fixed interest rate for the initial period of 3 to 5 years, after which the mortgage loan rates may be reset every year by the home mortgage company.
There may be a periodic rate cap that limits the amount the interest can change in each interest rate adjustment period. There may also be a lifetime cap that limits the maximum and minimum mortgage interest rates that you can be asked to pay over the term of the loan.
Fixed rate mortgages usually have a higher interest rate than ARMs. They are popular because the interest rate is fixed, and borrowers know how much they will have to pay. Ask mortgage companies if there are any prepayment limitations or penalties.
An ARM may be a better choice if the current interest rates of fixed rate mortgages are too high, or if you only plan to keep the home for a few years. An ARM may also be preferable if you expect your income to go up in the future.
You can also opt for short-term convertible home purchase mortgages that allow borrowers to start with a low variable interest rate, and then convert to a fixed rate mortgage on or before a specified date. Borrowers can lock in the interest rate when they feel the time is right.
Balloon mortgages are short-term loans with fixed interest rates, which allow borrowers to repay only a small part of the principal. The balance amount has to be repaid as a lump sum at the end of the term, which is usually of 3, 5, or 7 years. Borrowers usually choose to refinance the balance principal amount or to repay it by selling the home.
People who want to minimize their monthly payments until they can refinance the mortgage may opt for a balloon mortgage. Some borrowers also prefer them because they can claim a higher mortgage interest tax deduction.
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