We here at AML are fans of efficiency, beauty and simplicity. That goes without saying -particularly when it comes to taking on a home loan (aka: mortgage). Working in the finance industry, we had a head’s up on the type of loan options out there when we purchased our home a few years ago. Despite our knowledge, we still found the home loan shopping process overwhelming!
Let us simplify the convoluted array of options out there to help you make the best decision for yourself when it comes time to shop for your home loan. When it comes down to it, there are 3 main types of home loans available to you today. Let us explain.
Fixed Rate Mortgage
A mortgage in which the interest rate remains the same throughout the entire life of the loan is a fixed rate mortgage. These loans are the most popular ones, representing over 75% of all home loans. They usually come in terms of 30, 15, or 10 years, with the 30-year option being the most popular. While the 30-year option is the most popular, a 15-year builds equity much faster.
The biggest advantage of having a fixed rate is that the homeowner knows exactly when the interest and principal payments will be for the length of the loan. This allows the homeowner to budget easier because they know that the interest rate will never change for the duration of the loan.
Adjustable Rate Mortgage (ARM)
A mortgage loan in which the interest rate changes based on a specific schedule after a “fixed period” at the beginning of the loan, is called an adjustable rate mortgage or ARM. This type of loan is considered to be riskier because the payment can change significantly. In exchange for the risk associated with an ARM, the homeowner is rewarded with an interest rate lower than that of a 30 year fixed rate.
Obtaining an adjustable rate mortgage can allow the customer to qualify for a loan amount that is higher and therefore acquire a more valuable home. Many homeowners with extremely large mortgages can get the one year adjustable rate mortgages and refinance them each year. The low rate lets them buy a more expensive home, and they pay a lower mortgage payment so long as interest rates do not rise.
The loan is considered to be rather risky because the payment can change from year to year in significant amounts. Unless the buyer plans to quickly flip the property or has plenty of other assets and is using an interest-only loan as a tax write off, almost anyone taking adjustable rates should try to pay extra in order to build up equity in case the market turns south.
Balloon mortgages last for a much shorter term and work a lot like a fixed-rate mortgage. The monthly payments are lower because of a large balloon payment at the end of the loan. The reason why the payments are lower is because it is primarily interest that is being paid monthly. Balloon mortgages are great for responsible borrowers with the intentions of selling the home before the due date of the balloon payment. However, homeowners can run into big trouble if they cannot afford the balloon payment, especially if they are required to refinance the balloon payment through the lender of the original loan.
SO, what loan did we go with when we purchased our home? Well, based on the current historically low interest rates, our career goals and our want to stay in home we were purchasing for many years to come, we chose to go with a 30 year fixed rate home loan. That simply made sense to us based on our criteria noted above. Is this decision right for you? Maybe not. Each type of loan has it’s benefits and deficits. There is no right or wrong way. It is simply based on what makes the most sense to YOU based on your current and expected future lifestyle.
-Cassandra & Shaun