Most first-time homebuyers don’t realize how many different types of mortgages are available. The difference between mortgage types isn’t just in the APR offered. The risk level and flexibility of mortgages can make one much more suitable for you. Here is an overview of the main mortgage types and who they best suit.
Fixed Rate Mortgages
Fixed rate mortgages have a set interest rate and monthly payment amount which will not change for the entire duration of the loan. Fixed rate mortgages are amortized, meaning that each payment goes towards interest and principal so that, over the course of payments, your debt shrinks until the loan is completely paid off. The duration of the fixed rate mortgage will affect the interest rate. The shorter the period (such as 5 or 10 years), the lower the interest rate will be.
Fixed rate mortgages are ideal for buyers who plan on staying in the same property for a long period of time. They are also ideal for people who prefer the security of set interest and payments, especially if they think interest rates will increase.
Adjustable Rate Mortgages (ARMs)
Adjustable rate mortgages have an interest rate which will periodically change according to the Federal Reserve’s rates. Usually, the changes occur every 3 to 5 years. When the interest rates change, so will the monthly payment amount. ARM mortgages usually have lower APRs than fixed rate mortgages. If the interest rates do not increase much or go down, then they can be much more cost effective than a fixed-rate mortgage. However, there is always the risk of the interest rate increasingly significantly.
ARM mortgages are ideal for buyers who plan on spending just a short period of time in their home, such as fewer than 5 years. ARM mortgages are also ideal if the buyer has good reason to believe that interest rates will fall and are willing to take the risk in order to get the better APR.
A hybrid mortgage combines a fixed-rate and an adjustable-rate mortgage. For an initial period, the mortgage will be at a fixed rate. When that period is up, it will be converted to an ARM. You will usually see hybrid mortgages listed as ratios like 3/1. The first number is the length of time in years for which the mortgage rate will be fixed. The second number is how often the interest rate will be adjusted once the fixed-rate period is up. Hybrid mortgages usually have much better rates than fixed rate mortgages and are just a bit more than what an ARM would offer.
A hybrid mortgage is ideal if you are going to be in your home for a medium period of time, such as 5-10 years, and want the security of a fixed rate while still taking advantage of the lower ARPs associated with ARMs.