Types of Mortgages – Pros and Cons of Each Option
When it comes to financing your new home, there are various options available. Each has its advantages and drawbacks, so it’s essential that you comprehend them before making a final decision.
Selecting the ideal mortgage can save you money in the long run. Your decision should be based on both your financial objectives and the property that you plan to buy.
Fixed Rate Mortgages
The most popular mortgage option is the fixed rate mortgage (FRM). Unlike adjustable-rate loans that fluctuate according to interest rate changes, fixed rate loans provide buyers with security that their monthly payment will remain fixed throughout the duration of the loan.
Fixed-rate loans typically offer terms of 10, 15, or 30 years, allowing borrowers to spread their payments over a longer period and reduce overall mortgage costs. Unfortunately, fixed rate loans may prove more costly in the beginning years compared to adjustable-rate mortgages (ARMs) during these crucial early years.
If you want to pay off your home faster or have good credit and an income, a fixed-rate mortgage might be suitable for you. But be sure to research other options first before making any final decisions.
Fixed-rate mortgages are accessible and can be funded at nearly any lender, including banks, credit unions and mortgage lenders. To get the best terms and rates before applying, it’s essential to shop around; a low initial rate may increase rapidly once the introductory period ends.
Another potential drawback to fixed-rate loans is that you cannot adjust your mortgage payment if you move before the term ends. You may, however, make extra payments against principal to reduce interest costs, though be aware that some mortgage lenders charge prepayment penalties if this option is chosen.
Additionally, fixed-rate mortgages usually come with fees for taking out a new loan before the fixed rate period ends, and some lenders charge breakage fees if you remortgage to another lender before your fixed-rate deal ends.
If you’re uncertain if a fixed-rate mortgage is suitable for you, consulting an experienced mortgage broker is recommended. They can assist in finding an attractive rate and guiding you through the process.
Typically, fixed-rate mortgage terms range from 10 to 30 years; however, some lenders now offer longer terms up to 40 years. Your length of term depends on several factors including your financial situation and whether or not you plan to relocate or remortgage soon.
Adjustable Rate Mortgages
Adjustable rate mortgages (ARMs) can be an attractive way to purchase a home, but they also carry risks. Unfortunately, they’ve had a bad reputation since the recession; however, it appears they have now begun to repair their image and become an important tool for borrowers.
One of the major appeals of ARMs is their usually low initial rates, which can save you money in the long run. Unfortunately, there’s also a risk that interest rates will increase in the future and result in higher monthly payments.
Loans typically feature an initial fixed period – three, five or seven years – and then the interest rate changes annually after that. During this adjustment period, you’ll pay an interest rate that fluctuates based on market conditions.
Another popular ARM type is the 10/1 ARM, which features a fixed rate for 10 years and then adjusts annually. You may also come across other numbers like 2/28 or 5/1 on your ARMs.
Some ARMs feature caps that restrict how much the interest rate can change during the adjustment period. This is especially pertinent for borrowers who don’t plan on staying in their home long after the initial rate period has elapsed.
Aside from the interest rate, an ARM may offer other features to make your monthly payments more manageable. These could include a reduced payment amount, lower principal and interest payments, or the option to make extra payments on your loan.
No matter which ARM you opt for, it is essential to understand how the loan works before signing on the dotted line. The best way to find out is by asking your lender for a loan estimate.
Calculating your monthly payment for an adjustable rate mortgage is easy with a calculator. Just take into account how much the interest rate will rise over the course of the loan and add in other expenses like homeowner insurance and property taxes as well.
Generally, an adjustable rate mortgage is a great choice for people who plan to leave their home soon after the introductory period ends or who want to refinance at a later date. They may also be suitable for individuals with large down payments who can afford higher monthly payments.
Interest Only Loans
Interest only loans are a popular choice for investors who need to make an initial payment on their property without committing to paying the principal until the loan term ends. They offer several advantages to investors, such as lower monthly costs and the chance to invest extra cash into investments that may provide better returns than mortgages do.
Many buyers with limited funds, such as first-time homebuyers or those anticipating an income boost in the near future, find low initial payments to be an appealing feature. Furthermore, these borrowers can use the loan principal amount for investing in a retirement account which may yield a higher rate of return than their mortgage interest payments.
Investors can save money on mortgage insurance, which is typically required on an interest-only loan. These savings can then be applied towards paying off the loan at its conclusion.
Investors may use an interest-only loan to purchase a larger property than what is possible with traditional mortgage. Although the payments will be higher in the future, refinancing the loan is possible at any time.
Interest rates rising can lead to increases in payments for homeowners. For those planning on staying in their property long-term, this could present a problem as they would need to make additional principal payments or risk losing the home altogether.
Interest-only loans are frequently structured as adjustable-rate mortgages (ARMs), which can adjust interest rates periodically according to an index. As these loans carry greater risk than fixed rate mortgages, they have stricter qualifying criteria.
Qualifying for these loans can be challenging, and lenders typically require proof of sufficient earnings and a sound repayment plan. Furthermore, they require higher down payments than conventional mortgages require, and those with good credit must have a debt-to-income ratio below 50%.
Interest-only loans remain a popular option for some homebuyers despite their drawbacks. For example, young professionals who anticipate earning substantial income in the coming years but need to stay within budget in the meantime can find these loans to be extremely helpful.
Jumbo Loans
If you’re looking to purchase a luxury home, build an investment property or invest in high-end rental property, jumbo loans can be an attractive financing option. But before applying for one, it is essential to understand its pros and cons so you can make an informed decision.
Jumbo Mortgages Offer Benefits
One major advantage of jumbo mortgages is that they enable you to purchase more expensive homes than conventional loan limits in your area permit. This gives you the luxury of getting a larger house within budget, which could be ideal for your family’s needs.
But you should keep in mind that jumbo loans tend to come with higher interest rates and larger down payments than conforming mortgages. Furthermore, they require more documentation than standard loans, which could prove overwhelming if you have no prior experience applying for large loans.
A lender might request your tax returns, W2 forms, business documents and other financial records to prove your income. They’ll also check to see if you have enough cash reserves to cover at least six months’ worth of mortgage payments plus closing costs and any other expenses incurred during the process.
Jumbo Mortgages and the Con of Jumbo Loans
As previously discussed, jumbo mortgages exceed conforming loan limits set by Fannie Mae and Freddie Mac – government-sponsored enterprises (GSEs). Because these loans are not insured or purchased by these GSEs, lenders often have more stringent requirements for these loans than for traditional conforming ones.
Furthermore, a borrower’s credit score is an essential element in qualifying for a jumbo mortgage. Lenders generally require at least a FICO score of 700 to determine eligibility.
When considering whether a jumbo mortgage is right for you, your debt-to-income ratio (DTI) should be taken into account. According to JPMorgan Chase & Co., lenders may be willing to go higher if there are documented substantial cash reserves left over after the loan closes.