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The Different Types of Home Loans

The goal of home ownership is a dream for many. They may spend hours looking at real estate guides, viewing homes for sale online, and visiting open houses in the hopes of finding the perfect place. Finding the right home may seem like the biggest step, but getting a loan to buy the house is the most important one. It should be the first step, since you can’t own the perfect home that you find without it.

The process of getting a home loan is complex and needs to be thoroughly understood. You can avoid many mistakes if you learn about getting a home loan before you begin.

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Types of Home Loans

The first thing you need to know is what type of loan you want to get. There are numerous options, some of which are available to everyone and others that are restricted. Each one has certain advantages and disadvantages.

Fixed rate

This type of loan is probably the most well-known, but there are variations within it. They are based on the length of the loan and can be 15, 20, 30, or even 40 or 50 years. The payments are spread out over the entire term at equal amounts.

Payments get credited to the interest first and the rest of the amount goes towards the principle. In the early years, almost all of the payment will be interest. Towards the later part of the loan, most of the payment will be to reduce the principle.

What are the benefits of a fixed rate loan?

The main reason borrowers gravitate towards a fixed rate loan is the predictability it provides. They will be paying the same amount each month and will be able to budget it in. The interest rate will also stay the same even if rates go up or down. If they have a really good rate, this will save them money as interest rates raise.

There isn’t any disadvantage to choosing a fixed rate loan. Even if the rate drops lower than what you are paying, you can always consider refinancing to the lower rate.

Adjustable rate loans

This is often a popular loan, but it can be quite confusing to many borrowers who may not understand all of the terminology. The basis of this loan is that the interest rate fluctuates, which means your payments will also change.

There are many choices in adjustable rate mortgages, but the most popular are 5/1, 3/1, and 2/1 loans. What these terms mean is that the loan is at a fixed rate for so many years (the first number in the equation) and then has one adjustment for the rest of the loan term.

Many people are attracted to this type of loan because the initial interest rate is lower than a fixed rate. What they don’t realize is that the rate can go up drastically when it is time to be adjusted. Your payments can go up several hundreds of dollars and make it difficult or impossible to keep up with.

Why would someone choose the unpredictability of an adjustable mortgage? If they are buying their first home and in an entry level position at a job, they may find a lower payment helpful for buying a home sooner. They may believe that when the loan is adjusted, they will be making more money or will be able to refinance.

If you choose an adjustable loan, when it comes time to adjust the rate, you have basically three options if you cannot make the increased payments. You can either refinance, talk to a credit counselor about a program that will lower the payments temporarily, or you can sell your home. None of these are guaranteed to help you, and you can end up losing your home to foreclosure.

While adjustable rate mortgages are a viable product in the loan industry, you need to understand how they work and make an informed decision as to whether they will work for you.

Interest only mortgage

With this loan, you can make payments that are just for the interest, which will make your payments lower. Of course, you can’t make this type of payment forever; you will have to make payments on the principle at some point. Often, you are given the option to pay only the interest for a specific period of time, usually five or ten years.

The advantage to this loan is lower payments during the interest-only term, which can be beneficial to first-time home buyers. The disadvantage is a higher interest rate than with other loans. One of the dangers in choosing this type of loan is that you will not have any equity in the home if you need to sell since you have not made any payments to the principle.

People who choose this type of loan may have careers that fluctuate in income. For instance, a construction worker won’t have as much work during the winter. A salesperson may have less business in certain months. It is during those low periods that it will benefit them to only make an interest payment. When they have high income periods, they can pay extra on the principle.

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