With a fixed-rate home loan, your interest rate remains the same for the life of the loan and the payment is split into equal monthly payments for the duration.
During the first few years, only a small portion of the payment pays off principal. Most goes to pay off interest.
"Fixed-rate home loans can be 10 years, 15 years or 20, but most popular is the 30-year because that makes your payment the lowest," says Floyd Walters, owner of BWA Mortgage in La Canada Flintridge, California.
Unlike a fixed-rate home loan, which sports an unchanging interest rate over the life of the loan, the interest rate on an adjustable-rate mortgage, or ARM, can change from year to year.
Hybrid ARMs, which are prevalent, feature aspects of both adjustable-rate and fixed-rate mortgages.
"Hybrid mortgages can be anything from a three-year, five-year, seven-year or 10-year fixed interest rate period," says Mark Klein, executive vice president of Skyline Home Loans in Calabasas, California. After the fixed-rate period, the loan is amortized over the balance of the term with a rate that adjusts annually.
"The lender will say, 'We will fix your interest rate at 4 percent for the next five years. At the end of five years, we will go out and find the value of one-year Treasury bills and add a margin to that and we will fix your interest rate on the loan for a year at a time based on that (index and margin),'" Walters says.
Typically, there will be a cap on the initial interest rate reset that is higher than all of the subsequent rate adjustments, and a cap on the amount the rate can change over the life of the loan.
Interest-only jumbo loan
© Ernest R. Prim/Shutterstock.com
For affluent homebuyers with irregular incomes, the interest-only mortgage jumbo product, as its name implies, allows the option of paying only the interest for the first few years of the loan.
"You can pay principal if you wish; interest-only is an option," Walters says.
Today, interest-only mortgages are mostly jumbo loans. In the country's highest-cost housing markets, a jumbo loan is a mortgage for more than $625,500.
Interest-only loans are structured like an adjustable-rate mortgage. The interest-only period lasts for the first five, seven or 10 years. After that, the rate typically adjusts annually, and the borrower pays principal, as well as interest.
"When it resets, your payments can go up pretty significantly, even if the interest rate doesn't change that much," Klein says.
No matter what kind of loan gets you into a home, do your homework beforehand and make sure there are no details about the mortgage loan you don't understand.