The Different Types of Mortgage Loans and Which One Fits

17 February 2023

The Different Types of Mortgage Loans and Which One Fits You Best

When it comes to mortgage loans, the type you select depends on your individual financial situation. It’s essential that you comprehend both the advantages and drawbacks of each before making a final decision.

When purchasing or refinancing your first home or looking to refinance, it’s essential to know which loan type you qualify for and which one meets your needs. We have outlined the main types of mortgages and what each offers so that you can make an informed decision.
Types of Mortgages

When purchasing a new home, refinancing your current mortgage or just thinking about getting one, it’s essential to understand the various types of mortgage loans available and which one best fits you. Your choice will depend on several factors such as your credit score, down payment amount, desired home size and whether long-term residency will be in the property.

Fixed-rate mortgages are the most popular home loan type and usually the best choice for most people. With this loan type, your interest rate remains fixed throughout its term – typically 15 or 30 years.

Adjustable-rate mortgages (ARMs) are popular among homebuyers, but they come with some potential drawbacks: The interest rate on an ARM can change after a set period of time – usually 5, 7 or 10 years – when market conditions shift.

Many ARMs offer lower interest rates than fixed-rate mortgages, which may be a major attraction for buyers who don’t plan to remain in their home long. It is important that borrowers read the details of an ARM carefully so they understand what will happen to their interest rate and monthly payments after the introductory rate expires.

People looking to purchase a home may consider taking out a reverse mortgage, which allows homeowners age 62 or older to use the equity in their house as collateral and pay off debt. These loans could be an ideal solution for those with poor credit histories who don’t want to invest significantly in down payments.

Finally, there are specialty loans such as construction or home renovation loans. These short-term loans often feature variable or fixed rates and can be used for home improvements and to pay off the balance of a first mortgage.

If you’re uncertain which loan type to select, use this mortgage calculator to estimate your payment and explore all your available options. After that, shop around and get quotes from lenders to find the best mortgage for your needs.
Fixed Rate Loan

Fixed rate loans are popular among home buyers, particularly those looking to secure a lower interest rate in the long term. These loans can be obtained from banks, credit unions and mortgage lenders alike as well as government-insured programs like FHA or VA.

Borrowers who select fixed-rate mortgages typically do so for the security of knowing their monthly payments throughout the life of the loan. This provides major advantage, as budgeting can be done based on this fixed cost.

On a fixed rate loan, your monthly payment amount is determined by the total of both interest charges and principal. Your payment may increase if there are additional costs such as real estate taxes, homeowners insurance or mortgage insurance to pay.

Finding a competitive interest rate on your loan requires shopping around. The Consumer Financial Protection Bureau offers an online tool that allows you to compare rates from various lenders. Be sure to also take note of fees, points and closing costs when making your decision.

If you’re searching for a lower interest rate, an adjustable-rate mortgage (ARM) might be your answer. These loans offer an initial fixed rate period and then periodically reassess your rate. While the initial interest rate with an ARM may be lower than traditional fixed-rate mortgages, keep in mind that after this initial fixed period the adjustable portion may increase in price.

Arm loans come with a selection of fixed periods, so you can pick the one that works best for your lifestyle. For instance, a 7/6 ARM has a fixed rate for seven years and then adjusts every six months after that.

Variable-rate mortgages, on the other hand, adjust according to changes in market interest rates. They can be structured on either a direct, index plus margin or movement basis.

Mortgage loans for high-quality borrowers with excellent credit are generally only available to those who possess excellent credentials. A good credit score guarantees you the lowest possible interest rate, while a poor one could result in higher rates and more costly fees.

Here are the primary types of mortgage loans, but there are plenty more to consider. When making your decision, take into account factors like loan term, amortization and payment frequency.
Adjustable Rate Loan

Adjustable rate loans are a popular mortgage choice due to their lower introductory rates, which can help borrowers save money during the early years of a loan. They also provide some long-term stability; however, it should be noted that interest rates may change throughout the course of the loan’s existence.

An adjustable-rate mortgage (ARM) features a fixed interest rate for an agreed upon period (usually 5, 7, or 10 years). At that point, the loan switches to a variable rate which fluctuates according to market conditions and depends on the financial index that it’s benchmarked against.

The ARM typically comes in three main forms: hybrid, interest-only and payment option. Hybrid ARMs begin with a fixed interest rate for an agreed upon period and then switch to adjustable rate after that period ends. If interest rates rise during this interest-only period, borrowers pay less on their monthly payments but end up paying more overall due to having to cover interest and principal for the entire length of the loan.

Many ARMs feature caps, which restrict how much the interest rate can increase during its initial fixed period and on subsequent anniversaries. The cap may be as high as 20% of either the initial interest rate or total rate that could change throughout loan life.

These caps safeguard borrowers from being stuck with an interest rate that is either too high or low. If the rate is excessively high, it could make managing your monthly payment difficult.

If the interest rate on your loan is too low, it could make it difficult to stay current with payments on time. You may need to reduce your spending in order to make ends meet.

When selecting between an ARM or traditional fixed-rate mortgage, it’s important to understand the distinctions between them. Before signing on the dotted line, be sure to inquire about lenders’ eligibility criteria and terms.

If you’re uncertain which mortgage type is ideal for you, Bankrate’s ARM calculator can help determine the best fit.
Jumbo Loan

If you’re purchasing a home in an expensive area, a jumbo loan could be ideal for you. These mortgages exceed the limits established annually by Fannie Mae and Freddie Mac and allow lenders to offer larger loans without risking their reputation for offering reasonable deals.

Jumbo loans can be a great option for those who otherwise couldn’t purchase a home, but they come with some major drawbacks. Most notably, they carry an extremely high interest rate and often require large down payments in order to qualify.

Jumbo loans carry more risk for lenders, so their underwriting requirements are stricter than other types of mortgages. Therefore, those interested in getting a jumbo loan should shop around to find a lender with more accommodating lending criteria that fits their individual situation.

Jumbo mortgages are classified as non-conforming loans because they lack backing from government agencies like FHA or VA, meaning that they do not carry the same consumer protections as conforming loans.

Jumbo mortgages remain accessible to qualified borrowers, even if they may not be suitable for everyone. To fully understand what jumbo mortgage loans entail and how they function, it’s essential to understand both their risks and rewards so you can compare them against other loan options.

Jumbo mortgages offer the greatest potential for home ownership, especially if you live in an expensive neighborhood and lack the down payment required for conforming loans.

Another advantage of a jumbo mortgage is that its monthly payments are more manageable. Jumbo loans usually carry higher interest rates than conforming loans, though this is not always the case. Plus, if you plan to refinance your jumbo loan in the future, you could potentially lock in a lower rate than with a conforming loan.

In some cases, you may be able to cover a higher-than-conforming loan amount with a piggyback loan – this second mortgage on the same property that helps reduce the total debt on your primary mortgage. These loans can be found from various banks and credit unions.