The Workings of Mortgages

Taking out a mortgage to finance the purchase of a home can be very confusing. There are lots of different types of loans to fit any financial situation, and to ensure you get the best one you must understand how mortgages work and which one you will be best with in the long rung.

The most traditional type of mortgage loan is called a fixed rate mortgage. A fixed rate mortgage is extremely defined from the start including a rate that stays constant through the duration of the loan, which makes every monthly payment exactly the same and thus predictable so you can plan financially around the mortgage payment. Along with a fixed rate the duration of the mortgage is also predetermined, usually for a length of fifteen to thirty years. These loans are nice because the payment does not change with rising or falling interest rates, and are easily managed as long as the amount of money borrowed is not too large in the first place. You can find more information about fixed rate mortgages in our Info Center.

The next type of mortgage we will discuss is known as an ARM, an adjustable rate mortgage. The difference between a fixed rate mortgage and an ARM is that as mortgage interest rates rise or fall in the country the rate associated with the ARM rises or falls as well. This can be beneficial or negative based on whether the rate at the time is rising or falling. When the rate of a loan becomes higher or lower the monthly payments adjust accordingly which can prove burdensome for people with less discretionary income. The problem comes that if an ARM rate becomes too high then it can be difficult to pay the monthly payment every month, subsequently causing people to default on their loans and loose their homes to foreclosure. If you are confident the rates in the market will stay low or not rise higher than you can afford an ARM could be great if the rates go lower.

Another type of mortgage for people with less than perfect credit is known as a sub prime mortgage. These are mortgage loans made to people who normally could not obtain a loan at the expense of a much higher interest rate. In order for lenders to take the chance on people who have previously had blemishes on their credit record they need to garnish a bigger reward for themselves in the end. Thus they charge a much higher interest to people with lower credit. Sub prime mortgage rates are largely based on what credit score the borrower has, as well as current financial situations.

The three other types of mortgages that are seen enough to be noted are Jumbo, Balloon, and Two-Step mortgages. These are just various twists on mortgages based on a person's financial situation and mortgage loan needs. A Jumbo loan happens when a person needs to borrow a larger amount of money than the limit on regular conforming loans set by Fannie Mae and Freddie Mac. The larger amount of money is borrowed usually at a higher interest rate. A Balloon loan is a loan that has a lower interest rate for the first couple of years than would normally be given to a person for the amount of the loan, but after the pre-decided period in which they receive a low rate they must pay off the principle or refinance. A Two-Step mortgage involves paying a fixed rate for a certain period of time, then readjusting the rate only once for the duration of the mortgage. All these types of mortgages are detailed more elsewhere in our learning center.

Basically these are the ways in which a person can finance the purchase of a house. They all have their ups and downs, some are better than others in various circumstances, but overall these are the typical ways in which mortgages are repaid in the current mortgage lending system.