The number of home loans has been steadily on the rise, reaching nearly 3.2 million across the U.S in the past few years. But with so many types of mortgages available to homebuyers, how can you choose the best one for your new home purchase?
Every homebuyer’s personal situation is different, and there is no “one-size-fits-all” kind of mortgage. When you work with a reputable lender, they should be more concerned with your financial security than simply adding a loan to their portfolio. A trust-worthy lender will help you weigh your options so you choose the type of mortgage that’s in your best interest, not theirs.
We’re breaking down all the popular mortgage options, weighing the pros and cons of each, to help you find the best mortgage product to suit your needs.
When you apply for a fixed-rate mortgage, you lock in a current interest rate which will stay the same for the duration of your loan. While the balance of principal and interest change with each monthly payment, the total payment stays the same each month.
• Payments stays the same for the entire life of the loan
• Predictability in your monthly expenses
• Easier to comparison shop for fixed-rate mortgages
• Don’t usually carry prepayment penalties
• To take advantage of falling interest rates, you’ll need to refinance your loan
• The longer the mortgage, the more interest you pay
• May not see benefits of a fixed-rate unless you plan on making this your “forever” home
Unlike a fixed-rate mortgage, an adjustable-rate mortgage carries an interest rate that fluctuates over time. An initial interest rate, usually set below market rate, is charged for a period of time (can vary from one month to ten years), after which the rate adjusts incrementally for the remainder of the loan.
• Lower interest rate to start your loan
• Introductory rate is set below market rate
• There is a ceiling set for the highest interest rate you will pay during the adjustable-rate period
• Borrower can qualify for a larger loan
• After initial period, your interest rate will adjust at agreed upon increments (monthly, yearly) to meet the current market rate
• If held long enough, rates may surpass those of fixed-rate loans
• Monthly payments can change frequently
Choosing a 15-Year vs. a 30-Year Conventional Mortgage
Another common question about conventional types of mortgages is whether you choose a 15- or 30-year mortgage. Again, there is no right answer for everyone, but here is how payments break down for these two mortgage length options.
• Offers the lowest monthly payment
• Trade-off for that low payment is a significantly higher overall cost
• The extra 15 years is devoted primarily to paying interest
• Monthly payments are higher
• Offers a lower interest rate, so a larger amount of principal is repaid with each mortgage
• Short-term mortgages cost significantly less overall
The Home Buying Institute has more comprehensive information on making the choice between a 15- or 30-year mortgage. Other length terms may be available, such as 10- or 20-year mortgages, so ask your lender if these may be a better fit for your personal situation.
Non-Conventional Mortgage Options
The following types of mortgages are considered to be more risky. During the real estate boom in the early 2000s, these mortgage options allowed borrowers to qualify for larger loan amounts, with the idea that they would be able to earn more money or sell their house for a profit before their higher payments kicked in. But by the mid-2000s, the housing “bubble” burst and many borrowers found themselves with mortgages they could no longer afford to repay.
With a balloon mortgage, you’ll make payments over a set period of time (five to seven years), usually at a lower interest rate, after which you are expected to repay the remainder of the loan in a one-time, lump-sum payment.
• A fixed-rate loan with lower payments during an initial period
• Chance to refinance your mortgage to more traditional terms at the end of the initial period
• Must pay the entire balance of the loan with a one-time payment (unless you are able to refinance)
• Final payment can be more than 2x the average monthly payment
• Falling property values may make it hard to earn the money for final payment from the sale of your house
As the name implies, with an interest only mortgage you will repay only the interest on your mortgage for a fixed term (five to seven years). Once the initial period is complete, you will need to pay off the loan in a lump sum or begin paying both the interest and principal on the loan.
• Lower monthly payments during introductory period
• Borrower can refinance to a mortgage with more traditional terms after the fixed period
• Gives borrowers more time to save money before having to pay down the principal
• After the fixed period, borrower may be accountable for significantly higher payments
• Income and property value may not have grown during the fixed term, making lump sum or higher payments a hardship