Many novelty home mortgages — such as the “payment-option” loan — have disappeared in the wake of the housing bust. But homebuyers and homeowners who want to refinance still have several types of loans to choose from.
The most basic choices include fixed-rate mortgages, adjustable- or variable-rate mortgages and hybrid mortgages (which combine features of the fixed- and adjustable-rate options).
Fixed-rate home mortgages
The fixed-rate mortgage is a popular choice for homebuyers and homeowners because it offers peace of mind that the interest rate and monthly payment will remain unchanged for the entire term of the loan, typically 15 or 30 years. A fixed-rate loan with a 30-year term will have a slightly higher interest rate, but a significantly lower payment than a fixed-rate loan with a 15-year term.
Adjustable-rate home mortgages
The adjustable-rate mortgage, or ARM, gives the borrower a lower initial interest rate and a payment that may be more affordable than the rate and payment on a fixed-rate mortgage. However, the borrower should be prepared for the possibility that the low initial interest rate and payment on an ARM may not last. That’s because the rate and payment on an ARM typically adjusts (either higher or lower) according to a well-established interest-rate index, such as Libor. Rate adjustments often are subject to certain caps that limit the amount of the increase.
Hybrid home mortgages
Hybrid home loans come in two configurations. One format starts out with a low initial adjustable interest rate that makes the payment more affordable, and then converts to a fixed market rate — which may result in a higher payment — after a set number of years. The other format starts out with a fixed rate and payment for a set number of years, and then converts to an ARM, on which the payment may be either higher or lower, depending on market interest rates.
These loans are popular among homebuyers who intend to sell the home or refinance the mortgage, if possible, before the adjustment occurs.
Another type of home mortgage is an interest-only loan, on which the borrower makes a lower payment, but none of the amount is applied to the principal balance.