Mortgage Basics

March 27, 2009

With mortgage rates dropping these days due to the variety of stimulus programs you need to know about the different types of mortgages that are available. Here is a quick summary of mortgage types.

1. Fixed rate mortgage – This is a mortgage where monthly payments remain the same throughout the entire term of the loan.

Note that there are many types of fixed rate mortgages: ten year, fifteen year and thirty year. Generally the longer term that the mortgage is i.e. thirty years, the lower the monthly payment will be. Fifteen year mortgages, on the other hand, help buyers own their homes sooner. Even though their payments are larger, they build equity faster because more of each payment goes toward principal rather than interest. The lower interest rate and shortened term make the loans cheaper by lowering the overall interest bill.

2. Adjustable Rate Mortgage (ARM) – Unlike the fixed rate mortgage, the ARM rate changes based on the market and is typically tied to the prime rate. So if the prime rate were to go up, your monthly payment would also go up.

3. Balloon Mortgage – a balloon mortgage has payments similar to a thirty year fixed rate loan however the term of the balloon loan is shorter, most often spanning five to seven years. At the end of the loan term, you need to either pay off the loan or re-finance at the then current rate.

4. Interest Only Mortgage – In this case, the homeowner is allowed to pay only the interest for a specific period of time on the loan before the principal is paid. After the time has expired, the payments increase to include the principal. Note that this may not be a prudent way of paying a mortgage since higher payments overall will arise.

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