An Overview of the different mortgage types, including fixed-rate, adjustable rate, and balloon mortgages

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Mortgage Types

Like many other financial products, zillions of different mortgages are available to choose from. The differences can be important or trivial, expensive or cost-free.

There are two major types of mortgages – those with a fixed interest rate and those with a floating or variable rate. Your choice depends on your financial situation and how much risk you're willing to accept.

Fixed rate mortgages:
Fixed rate mortgages are the standard mortgages that ruled the whole market before variable-rate mortgages came along. Usually issued over a 15 or 30 year period, these mortgages have interest rates that never, ever change. The interest rate you pay the first month is the same one that you pay the last month, and every month in between. Not all fixed-rate mortgages offered by different banks have the same interest rate, but with a fixed-rate mortgage, you can lock in an interest rate that won't change for the life of your loan.

Because the interest rate stays the same, your monthly mortgage payment does not change. There's nothing complicated to track, and there is no uncertainty.

Comparing different fixed-rate mortgages is easier than comparing adjustables. But picking a fixed-rate mortgage is no walk in the park either. Points, application fees, appraisal fees, and prepayment penalties can quickly multiply your confusion.

Click here for more information on how to pick the best fixed rate mortgage.

Balloon loans:
Balloon loans start out the way traditional fixed-rate mortgages start out. You make level payments based on a long-term payment schedule, over 15 or 30 years, for example. But at a predetermined time – and well before the traditional end of such a loan – the remaining loan balance becomes fully due. Balloons typically need to be paid off within the first three to ten years.

Why, then would anyone want a balloon loan? One motivation is to save money. All things being equal, a balloon loan has a lower interest rate than a fixed rate mortgage. Sometimes, balloon loans may be the only option for the buyer. Buyers are more commonly backed into these loans during periods of high interest rates. When a buyer can't afford the payments in a conventional mortgage and really want a particular property, a seller may offer a balloon loan.

Avoid balloon loans. You should take such a loan only if the following three conditions are true:

  • You really, really want a certain property.
  • The balloon loan is your only financing option, and you've really done your homework to exhaust other financing options.
  • You're positive that you'll be able to refinance when the balloon comes due.

Adjustable-rate mortgages (ARMs)
In contrast to a fixed-rate mortgage, and adjustable-rate mortgage(ARM) carries an interest rate that varies. Like a fidgeting child, it moves, jumps, rises, falls, and otherwise can't sit still.

Some adjustables are more hyperactive an prone to get you into trouble than others – again, like kids. You can start with one interest rate this year and have different ones for every year, possible every month, during a 30-year mortgage. Thus, the size of your monthly payment fluctuates. Because a mortgage payment makes an unusually large dent in most homeowners' checkbooks anyway, signing up for an adjustable without understanding its risks is dangerous.

The advantage of an adjustable-rate mortgage is that if you purchase your property during a period of relatively high interest rates, you can start paying your mortgage with the artificially depressed initial interest rate. And if interest rates start to decline, you can capture the benefits over the next few years.

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