Step-by-Step Series #1: Financing Your New Home Purchase-Find a Conventional Mortgage Option to Fit Your Needs
A “conventional” mortgage is a mortgage that is not backed or insured by a government agency. Fixed-rate and adjustable-rate mortgages are the two main types of conventional mortgages, but there are other loan products available to fit your specific financial goals. Here are just a few of the most common mortgage products, along with some pros and cons to consider before you sign on the dotted line.
Fixed-rate Mortgage: A mortgage with an interest rate that does not change during the entire term of the loan.
Pros: No surprises. The fixed-rate mortgage offers the least risk of the conventional loan options listed in this article. The monthly payment and interest rate stays the same over the entire term, usually 15, 20, or 30 years.
Cons: If interest rates fall, you could be stuck paying a higher rate; however, refinancing your mortgage could be a solution to falling interest rates. A good rule of thumb is if you plan to be in your current home for several years and you can reduce your interest rate by 1.5% – 2%, or even more, refinancing is a good move.
The following mortgage products hold more risk and should be approached more carefully. You will need to have a thorough understanding of these products before you pursue these options.
Adjustable-rate Mortgage (ARM): A mortgage whose rate of interest is adjusted periodically to reflect current interest rates (also known as variable-rate mortgage).
Pros: Usually offers a lower initial rate of interest than fixed-rate loans.
Cons: After an initial period, interest rates fluctuate over the life of the loan, so when interest rates rise, generally so do your loan payments.
Balloon Mortgage: A mortgage with monthly payments often based on a 30-year amortization schedule, with the unpaid balance due in a lump sum payment at the end of a specific period of time (usually 5 or 7 years).
Pros: Usually a fixed-rate loan with relatively low payments for a fixed period.
Cons: Can be risky, since the unpaid balance of the loan is due immediately upon expiration of the initial period. However, the mortgage may contain an option to “reset” the interest rate to the current market rate and to extend the due date if certain conditions are met.
Interest-only Mortgage: A loan in which the borrower pays only the interest on the principal for a set term. During that term, the principal balance does not change.
Pros: During the fixed term, the borrower pays only the interest on the loan in monthly payments, usually resulting in smaller payments.
Cons: After an initial period, the balance of the loan is due. This could mean much higher payments, paying a lump sum, or refinancing.