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While 30-year fixed rate mortgages still make up the majority of mortgages being used by home owners today, it's possible for home buyers to secure what amounts to being a custom mortgage specifically designed to meet their unique financing needs.
Still, even heavily customized mortgages are typically some variation of one of just a few basic mortgage types.
Fixed-Rate
This is typically the choice of home buyers who want to know
exactly what their payment will be month after month for the life
of the loan. Often, the holders of these mortgages are committing
to the possibility of long-term residency. Principle and interest
payments remain exactly the same throughout the life of the loan,
which usually is 30 years, but can be 10, 15, 20, or even 40
years.
Adjustable-Rate
This mortgage has steadily gained in popularity in recent years.
It enables a home buyer to secure a loan at a lower interest rate
compared to the going fixed rate. The lower, adjustable rate is
typically locked in for the first year, or sometimes just a few
months, and then adjusts in subsequent years in relation to some
economic index - such as the prime lending rate or interest on
one-year Treasury bills. The rate can go up only a certain amount
in any given year, usually 1-2 percent. There is also a lifetime
cap on the increase, usually 6 percent. So an adjustable rate
mortgage that is secured at 5 percent could climb to as high as
11 percent in three years during a period of rapid inflation and
rising interest rates. In recent years, though, with negligible
inflation and declining or relatively stable interest rates,
adjustable rate mortgages have proven to be a wise buy, with
little fluctuation occurring. Still, the primary customers for
such mortgages are home buyers having trouble qualifying for a
house at a fixed rate because of lack of income, lack of down
payment, or too high an existing debt-to-income ratio. With an
adjustable-rate mortgage, such buyers can qualify for a larger
loan. If they're anticipating an increase in income or a lowering
of debt that will keep pace with the maximum increase in the
rates, it's a safe move. Often these buyers end up refinancing at
a fixed rate once their income enables them to do so - especially
if rates are going up or the home owner thinks they are about to
go up. An adjustable rate mortgage also is attractive to home
buyers who know they'll be staying in a house for only a few
years. Sometimes, the total payments made during those few years
can end up being less than the total if a fixed rate had been
used - even if the adjustable rate moves up its maximum amount
during those two to three years.
Two-step
These mortgages could be described as a hybrid of the fixed rate
and adjustable rate mortgages. Typically, such loans provide a
fixed rate for the first five or seven years of a 30-year
mortgage, then revert to a fixed or adjustable rate (convertible
or nonconvertible) for the remaining 25 or 23 years. The
adjustable or fixed rate at the end of the five- or seven-year
periods is typically tied to some predetermined index and will
also include a margin for the lender. So the home buyer is
accepting the risk of facing potentially higher rates after the
first five or seven years. But during the first five or seven
years, the interest rate is typically lower than the current
30-year fixed rate and higher than adjustable rates. So two-step
mortgages enable home buyers to secure a rate that's lower than
the fixed rate, but doesn't have the risk of the potentially
rapid increase that comes with an adjustable rate. Like
adjustable rate mortgages, these mortgages are especially
attractive to home buyers who plan to move within a short time
frame - in this case, five to seven years.
FHA
Not so much a mortgage type as it is a mortgage program, Federal
Housing Administration loans are backed by the U.S. government.
That means the lender is reimbursed by the federal government if
the borrower defaults on the loan. The primary benefit of the
program is that it enables home buyers to purchase a home with a
minimal down payment. Typically, just 5 percent is needed,
compared to the 20 percent down payment that's usually needed to
secure conventional financing. Some FHA programs enable certain
first-time home buyers in particular income brackets to buy a
home with a down payment as small as 3 percent. The size of an
FHA loan is limited, based on the average cost of housing within
a particular geographic area. So typically, a borrower using FHA
financing in a large metro area where housing prices are steep,
can borrow a much larger amount than the home buyer shopping in a
rural area with lower housing costs. While the down payment
qualifications are much easier to meet with FHA financing, that
doesn't necessarily translate to a better deal over the life of
the loan. Mortgage insurance premiums, required because of the
minimal down payment, will make monthly payments higher than
conventional loan payments at the same interest rate.
VA
Another U.S. government loan program is the Veterans
Administration loan, which is primarily designed to enable
qualifying veterans of the U.S. military to buy a home with no
down payment and minimal closing costs. Depending on your veteran
status, there is an origination fee that will add to the cost of
using this financing. A disabled veteran, for example, may not
need to pay any fee at all, while a reservist who hasn't seen
active duty might pay the maximum fee, which today can be as high
as 3 percent.
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