Know the Difference: Seven Common Mortgage Options
There are different types of mortgage products available from traditional lenders, credit unions, unconventional loan programs, and the federal government. Generally, different types of mortgage products are determined on the basis of credit worthiness and repayment method. While several options may be benficial in providing funding for your home purchase, it is important to remember that each option has its own pros and cons.
The most common mortgage product available is a fixed rate mortgage. In August 2009, the FHA limited this loan type to 30 years. As you would imagine, the interest rate is fixed for the entire term until the mortgage is paid in full. With a minimum credit score requirement of 640 and a debt-to-income ratio of less than 41%, this is the best mortgage option available, but it is important to inquire about prepayment penalties.
The next common option is an adjustable rate mortgage (ARM). Some lenders also refer to this as a variable mortgage. Regardless of the name which a lender uses, this option provides a short term fixed rate, usually three to five years, followed by a fluctuating interest rate for the remainder of the loan. Unfortunately, unlike a fixed rate mortgage, your interest rate can increase with the market and may cause your monthly mortgage payment to increase considerably, to an amount which becomes unmanageable. While this is more affordable than a fixed rate mortgage in the beginning, it can quickly cause financial issues.
A tracker mortgage is very similar to a ARM where your interest rate is free to increase or decrease as the market changes. Where it differs is the fluctuation will lock at a specific interest rate—usually 0.85% over the market average—for a set period of time before increasing or decreasing again. Like a fixed mortgage, there can be charges for early repayments and, like an ARM, budgeting may become more difficult as monthly payments fluctuate.
An alternative, which combines a fixed rate mortgage and an ARM, is the capped mortgage. This option allows your interest rate to adjust with the market, but the interest rate will not rise past a certain fixed interest rate. For example, the lender standard variable rate is set at 7%. If the market average raises to 8%, your interest rate will remain fixed at 7%; but, if the market average drops to 4% your interest rate will also drop to 4%. The benefits of such mortgage types include knowing the maximum budget rate. You can calculate your budget knowing the maximum cost while saving money when interest rates are low.Continued on the next page