When it comes to getting a mortgage loan, homebuyers have fewer options than they did even a couple of years ago. In the days of the real estate boom, lenders were much more willing to float exotic loans based on risky terms, but recently they have returned to safe and sensible home financing.
Homebuyers hoping to jump into the mortgage market will find three basic types of loans, for the most part.
Fixed-interest mortgageWith 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. In other words, it is amortized over the life of the loan.
The interest payments are front-loaded, however, so that during the first few years of the loan term, only a small portion of the payment pays off the principal. To see an example of an amortization schedule, plug in some hypothetical numbers in Bankrate's mortgage calculator.
Most commonly taken as a 30-year loan, fixed-rate mortgages can be shorter in duration or, more rarely, longer.
"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, Calif.
During the height of the real estate bubble, news broke about even longer loan terms, with some mortgages being offered for a long as 50 years. Those may have been more of an urban myth than reality, says Walters.
"To be honest, I never saw a real offering for a 50-year mortgage. I did see just a few lenders offering a 40-year mortgage," he says.
An extremely long mortgage term offers few advantages to consumers.
"On a fully amortized 30-year fixed-rate loan at 5.25 percent for $250,000, the payments would be $1,380 per month. Take that same loan out another 10 years to a 40-year note and the payments drop but only to $1,247 per month. You save $133 per month but it adds 10 years to your note with a net cost of an additional $100,000 or so," Walters says.
Adjustable-rate mortgageUnlike a fixed-rate home loan, which sports a static interest rate over the life of the loan, the interest rate on an adjustable-rate mortgage, or ARM, changes every year.
ARMs come in various permutations. For instance, a hybrid ARM features aspects of both adjustable 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, president of Pacific Coast Lending in Agoura Hills, Calif. After the fixed-rate period, the loan is amortized over the balance of the term with a rate that adjusts annually.
Conversely a one-year ARM has no fixed-rate period. Though they are still available, they're not widely offered, says Walters.
"It's hard to believe there are very many people taking a one-year. I haven't done one for years and years. It's just not a product that feels right," he says.
One circumstance when they might be appropriate would be in a high fixed-rate environment.
"If I could take a one-year ARM that was 1 or 2 percentage points below what I could get as a fixed-rate mortgage, and if I could get some interest rate caps built in, I would analyze it. If we were in a high fixed-rate environment, it might appear more attractive," Walters says.