How many kinds of mortgages are there? Lots! Let’s look at a few of the most common ones.
Written by Northwest Mortgage
Published on Tue, Aug 16, 2022, Last Updated on Tue, Aug 16, 2022
Does trying to learn about mortgages on the internet make your head spin? We don’t blame you!
In this blog, we’ll take a look at 2 of the most common mortgage types: fixed-rate and adjustable-rate mortgages. Specifically, we’ll talk about the “conforming” versions of these loans, meaning they can be bought by Fannie Mae or Freddie Mac (real-estate investment companies that buy mortgages from lenders). Non-conforming versions can’t be bought by Fannie or Freddie.
When Fannie or Freddie buy mortgages from lenders, the sale gives lenders more money so that they can loan more mortgages to people. This process allows communities to keep home ownership available to more people, instead of limiting the number of mortgages available by how much available money lenders have at any one time.
With that said, let’s get into it!
A fixed-rate mortgage is a mortgage that lasts a certain period of time (usually 30, 20, or 15 years) and keeps the interest rate the same for the entire duration of the mortgage. Simple!
This kind of mortgage accounts for around 90% of home buyers, according to Mortgage Professional America, specifically the 30-year fixed rate mortgage.
The fixed-rate mortgage is a relatively low-risk option for both lenders and buyers and benefits them both. Because the mortgage takes place over such a long period of time, buyers can pay less per-month while also having protection from changes and spikes in interest rates over time. For lenders, the long life of the loan means earning much more interest than on shorter mortgages.
Buyers who want to avoid paying lots of interest over time can opt for a shorter mortgage window (like 20 or 15 years), but will have to be able to field much higher monthly payments. However, paying off a long-term fixed-rate mortgage as soon as possible means that buyers can potentially save thousands of dollars in interest.
Rocket Mortgage suggests that a fixed-rate mortgage might be the best option for homebuyers that plan on living in that home for the full duration of the mortgage - in other words, for those buying their “forever home.”
An adjustable-rate mortgage (ARM) is a mortgage that can last the same period of time as a fixed-rate (either 30, 20, or 15 years) - the major difference is that the interest rate can change after a set period of time (anywhere from 3 to 10 years, depending on the mortgage itself).
An ARM usually gives the buyer a better-than-market interest rate for the first few years, allowing them to have low monthly payments. After that set period of a few years, the buyer’s interest rate will start to change and move with the market. It will usually change once per year on the anniversary of the loan.
Because the adjustments for interest rates depend on other indexes and factors, these mortgages are much more complex. In addition, ARMs are riskier because monthly payments can increase drastically, which could put the buyer’s ability to pay down the loan in jeopardy.
The contracts often must define rate caps and rate bottoms so that buyers aren’t perpetually threatened by constantly-climbing interest rates (and, therefore, constantly climbing monthly payments) and banks don’t get caught losing excessive amounts of money if rates go too low.
Rocket Mortgage says that individuals investing in a “starter home” that want to move before the duration of the loan is up might want to consider an ARM. In addition, the low rates at the beginning of the loan’s duration might allow homeowners to have more liquid income to put towards paying down their loan earlier. Just like fixed-rate mortgages, this approach can save the buyer thousands of dollars in interest.
That’s the skinny on these two kinds of mortgages, which account for a huge percentage of most mortgages today. If you have any questions about which type might be for you, contact us to schedule a consultation!