Since some mortgage options are more or less conservative than others, it’s important to determine if you are a risk-taker or if you prefer more stability in your financial dealings. Do you invest in the stock market? Or only put your money into Certificates of Deposit or savings accounts which are FDIC insured? These are two different ways of handling money. Depending on your answers to these and other questions, you will be able to choose the mortgage that is right for you.

Types of Mortgages

1. Fixed-Rate Mortgages
2. Adjustable-Rate Mortgages (ARMs)
3. The Hybrid ARM
4. Balloon Mortgages
5. FHA Loans
6. VA Loans
7. USDA Rural Housing Loans

Fixed-Rate Mortgages

If you’re looking for a mortgage with payments that will remain essentially unchanged over its term, or if you plan to stay in your new home for a long time, a fixed-rate mortgage is probably right for you.  The most popular fixed rate mortgages are amortized over 30 years – though fixed rate mortgages also come in 25, 20, 15, and 10 year terms.  Of course, the shorter the time period before you would be paying the mortgage off, the higher the payment, but the lower the overall interest cost for the mortgage.

With a fixed-rate mortgage, the interest rate you pay and the monthly principal and interest payments are agreed upon and will not change throughout the term of the mortgage. In other words, the interest rate you close with won’t change—and your payments of principal and interest will remain the same each month—until the mortgage is paid off.  As you can see, the fixed-rate mortgage is an extremely stable choice. You are protected from rising interest rates. And it makes budgeting for the future very easy.  While your principal and interest payment will not increase, your payment might increase if it includes your taxes and insurance because those two expenses do increase over time.

But in certain types of economies, interest rates for a fixed-rate mortgage can be considerably higher than the initial interest rate of other mortgage options. That is the one disadvantage of a fixed-rate mortgage. Once your rate is set, it does not change and you will not benefit from falling interest rates. However, you do have the option of refinancing if interest rates drop significantly – though at a cost.

Adjustable-Rate Mortgages (ARMs)

An adjustable-rate mortgage (ARM) is considerably different from a fixed-rate mortgage. It may be best if you’re buying a home while interest rates are high, if you expect increases in your income, or if you don’t plan to keep your home long. Keep in mind, with an ARM, you are taking the risk on the rise or fall of interest rates, not the bank.

In most cases, the initial interest rate of an ARM is considerably lower than a fixed-rate mortgage.

With an ARM, your mortgage rate rises and falls with interest rates in general. Each lender’s interest rates are usually tied to a specific index like COFI, LIBOR, the T-Bill rate, or the CD index. The rate you pay will be based on your lender’s index plus a margin (the profit the bank makes -usually two to three points.)  Current rates of indexes are published in the financial services media – including in the Wall Street Journal.   Ask your lender for specifics. Also ask how the “caps” on your ARM work. “Caps” will limit the amount your lender can increase your interest rate in a single year and over the entire term of the loan.

The Hybrid ARM

A “hybrid” ARM is a combination of an adjustable rate mortgage and a fixed rate mortgage.  These loans are initially fixed for a certain length of time – generally 1, 3, 5, 7. or 10 years.  After the initial fixed rate period, the loan turns into an adjustable mortgage in which the interest rate and the principal and interest payment can change – either once or twice a year.  If you hear someone discuss  a 5-1 ARM, this is a “hybrid”.  It means that the interest rate and the payment cannot change for the initial period 5 years and then it turns into an adjustable rate mortgage in which the interest and payment can change once per year.  This type of loan is especially attractive to those people who don’t plan on owning their home long term and want to take advantage of the generally lower rates that a “hybrid” will have compared to a fixed rate loan.  Just as no one wants to pay extra interest because their ARM went up and they still own their home, people also don’t want to pay the extra interest costs for a 30 year fixed loan when they won’t keep the home or the loan for more than a few years.

Balloon Mortgages

Another type of mortgage  is the balloon mortgage, so-called because it sometimes requires you to pay off your loan in full or refinance at the end of the mortgage term (usually five or seven years). The advantage of a balloon mortgage is that your monthly payments during the mortgage term are generally lower than they would be for a traditional 30-year fixed-rate mortgage.  Some balloon mortgages also have a “reset” feature which means that the loan will continue for a full 30 years but there will be one adjustment in the interest rate at the end of the initial period of five or seven years.

Balloon mortgages are traditionally popular with first-time home buyers with growing families and with individuals who expect to be relocated by their  employer. If you anticipate moving in five to seven years, you can take advantage of lower interest rates (sometimes from three-eighths to three-quarters of a percentage point less than traditional fixed-rate loans) for that time period. If you end up staying longer in your residence then you may have to pay the balance at the end of the term, or more likely, refinance your mortgage at the then-current interest rate if the balloon mortgage does not “reset” to a fixed rate mortgage at that time. If the lender does have  an option that allows you to convert this loan to a fixed-rate mortgage for the remainder of the term, then you must meet certain conditions – such as having a good payment history on your mortgage.

FHA (Federal Housing Administration) Loans

FHA  loans are available to Americans with smaller incomes who are buying modestly priced homes.  FHA is the most popular type of loan program for first time home buyers, buyers with limited funds for a down payment, people with lower credit scores, and/or people who will be getting help from a family member to buy a home.  While FHA loans can be placed on any single family home which is in reasonable condition, these loans can only be placed on condos which are “approved” by FHA.  Both FHA and VA loans have more restrictions in terms of the condition of the property but they are both more flexible in terms of credit scores, gift funds, and allowing a family member to go on the loan to help the borrower qualify.

VA Loans

Veterans may qualify for Veterans Administration mortgages. There are caps on the size of a VA loan you can get, but this loan may be ideal for buying a  home with no down payment.  Not all veterans qualify for a VA loan.  They must be able to get something called a “certificate of eligibility” from the Veterans Administration.  If one does have monies for a down payment and closing costs, then there is generally no advantage to getting a VA loan.

USDA Rural Housing Loans

One more type of government loan is the rural development loan.  This loan is specifically designed to help people who live in rural areas get into a home with little or no money down.  Some small towns and communities are considered rural.  The determination of what is considered rural is based on USDA maps.  If the property falls into an area on the USDA map which is considered rural, then a USDA loan may be placed on that home – assuming the buyer fits the other qualifications for the loan.  Under some circumstances, the cost of home repairs and even some appliances can be rolled into the loan.  There are several different types of USDA loans and most do have some income limits as they are designed for low-income people.