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What Type of Mortgage Do You Need?

Posted by Vintage Oaks
11.13.14

Topics: Vintage Oaks, buying a home, home buying, home mortgage

The type of mortgage you need depends on your individual situation. A good lender will help you determine your specific needs by evaluating your credit report, assets, and employment history. From there, they can recommend some options for you. Here's a rundown on the most common home loan types, from Zillow’s blog.

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Fixed-Rate Mortgage

Interest is fixed for an amount of time; e.g., 10, 15, 20, 30, or even 40 or 50 years, at which point the amortized principal is paid in full.

Pros: Security and consistency. You know what your payments will be and you have an option to refinance if rates drop significantly.

Cons: If rates go down, you'll still be paying the initial rate unless you refinance.

Adjustable-Rate Mortgages (ARMs)

The interest rate fluctuates with an indexed rate plus a set margin; adjustment intervals are predetermined. Minimum and maximum rate caps limit the size of the adjustment.

Pros: Initial rates are lower than fixed. Popular with those who aren't expecting to stay in a home for long, in a hot market where houses appreciate quickly, or for those expecting to refinance. You can qualify for a higher loan amount with an ARM (due to the lower initial interest rate). Annual ARMs have historically outperformed fixed rate loans.

Cons: Always assume that the rates will increase after the adjustment period on an ARM. You are betting that you'll save enough initially to offset the future rate increase.

1-yr. Treasury ARM

The rate is fixed for one year, then becomes adjustable every year. The new rate is determined by the treasury average index plus the loan margin (usually 2.25-2.5%). 30-yr. term.

Pros: Lower rates than a fixed mortgage. When rates go down, you benefit.

Cons: Watch the margin; the margin is added to the index to come up with the new rate after the adjustment period. When rates are going up, you could end up paying more interest than with a fixed.

Intermediate ARM

With an intermediate or hybrid ARM, the rate is fixed for a period of time, then adjusts on a predetermined schedule. This is shown by the number of years the loan is fixed, and the adjustment interval (.e.g., 3/1 ARM is 3 year fixed, and 1 adjustable annually). The new rate is determined by an economic index (usually treasury or treasury average index) plus the loan margin (usually 2.25-2.5%). 30-yr. term.

Pros: Lower rates than a fixed mortgage. When interest rates rise, you see more ARMs because they are easier to qualify for.

Cons: When rates are going up, you could end up paying more interest than a fixed-rate mortgage after the initial period.

Flexible Payment Option ARM

The borrower chooses from an assortment of payment methods every month. There is a "change cap" limiting how much payments can vary in a year.

Pros: Frees up cash when you need it. Good for buyers with variable incomes (e.g., salespeople who work on commission).

Cons: Some options won't cover your interest. With lower payments, your balance increases each month, and eventually your payments will increase substantially. This could lead to negative amortization.

Interest-only ARM

For a period of time, you pay only interest, and do not pay down the principal. This loan type was discontinued by Freddie Mac in 2010 and is offered by very few lenders.

Pros: If you don't plan to stay in a home long, you can buy something you ordinarily couldn't afford. If you are in a hot market, or a hot neighborhood, you'll have low payments while your house appreciates in value. You can always pay more on the principal while enjoying the low payments. One other great thing about an interest only mortgage is that payments made to the principal reduce your monthly payment. So, if you have a job that has a heavy non-scheduled bonus or a commission based compensation plan, you can pay the interest every month and when you get your bonuses pay down the principle to reduce your monthly payment.

Cons: The day will come when you need to pay down the principal. If your home value has fallen, or your income decreased, you could have trouble making the new payments. One strategy is to invest the difference between an interest-only loan and a fixed-rate loan to build up cash reserves.

Convertible ARM

An ARM that can be converted to fixed rate after a period of time.

Pros: Saves on refinance costs, assuming you would have been switching anyway.

Cons:You will have a higher rate for the fixed with a convertible loan. You can't look around for a better deal, which you can with a refinance.

Jumbo Loans

Above Freddie Mac and Fannie Mae conforming guidelines, therefore the big secondary lenders will not secure jumbo loans. 2013 maximum amount for a conforming loan: $417,000.

Pros: When the market is out of sight, the jumbo loans make a purchase possible.

Cons: Higher down payments, and higher interest rates.

Assumable Mortgage

An adjustable-rate loan, the balance of which can be assumed by a home buyer.

Pros: Sellers can offer a low interest rate to entice buyers.

Cons: This is almost never a fixed rate mortgage, so the savings might not be all that great.

Balloon Conforming Mortgage

Interest rate is fixed for a period of time, but the principal is not completely amortized. For the remainder of the term, it adjusts to a new fixed rate determined by the Fannie Mae net yield index plus the margin. 30-yr. term.

Pros: Lower monthly payments initially. If your career (and salary) has a good future, or you are in a hot market and plan to sell before the balloon comes due, you can save money.

Cons: Who knows what that new rate will be? There's a looming debt in your future.

Balloon Mortgage

The rate is fixed for a period of time, but the principal is not completely amortized during the period. The entire balance of the principal is due as a balloon payment at the end of that period.

Pros: Lower monthly payments, with the idea you can always refinance or sell before the balloon.

Cons: A big elephant waiting in the wings

VA Home Loans

A zero-down loan offered to veterans only; the VA guarantees the loan for lenders.

Pros: Nothing down, and no mortgage insurance. The loan is assumable.

Cons: The rate might be higher than conventional loans or FHA loans.

Federal Housing Administration Loans (FHA)

Government-subsidized loan with low down payment (i.e., 3.5 % of the sales price) and closing fees included; the government guarantees the loan.

Pros: Low rates for those who can't come up with the down payment or have less-than-perfect credit; great for first-time home-buyers. The loan is assumable.

Cons: If you can afford 5 percent down, you might find better rates with conventional loans

Since mortgages can be tricky, talk to your lender to find out what you can afford and ask for up to date rates and products that best fit your needs. You can read more about each option on Zillow’s blog. This will help keep your mortgage payments manageable for your dream home in Vintage Oaks. For more information on buying a new home in Vintage Oaks, click below to view our featured quick-move homes and download the Guide to Buying a New Home in the Hill Country.

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