Types of Mortgages
Who hangs out in the mortgage crowd? Let's take a look around the lunch table.
Fixed mortgages are the popular kid at the bank. Why? Because, with a fixed mortgage, the interest rate and the monthly amount of payment on your loan stay the same no matter what. No surprises when you open the bills.
Here's how it works: the amount of your monthly payments that is used to pay down the interest and the amount used to pay down the actual principal (the amount you've borrowed) changes over the years. Early on in your mortgage, you're going to be paying mostly just the interest. Later on, you'll be tackling the main borrowed amount.
As time passes, you continue to paying interest on whatever remains of the principal amount. As you slowly pay off your mortgage, you'll pay less interest (because the number you're paying interest on is smaller), so more of the cash will be put toward actually paying off your loan.
Example? Of course.
Let's say you borrowed $250,000 with a 6% interest over 30 years. In the first year, you'd pay about $15,000 in interest (.06 x $250,000). After the first twelve months, you'd have chipped away $3,384 of the $250,000 and you'd have $236,617 to repay. Then, you'd be paying 6% on $236,617.
By the time 20 years roll by, you'll be wearing your pants hiked up higher and you'll only have $123,522 of your $250,000 left to pay back. You'll still be paying the same amount each month, but only about $5,747 will go towards interest. The rest will go toward paying down that pesky loan you've been complaining about for two decades.
After 30 years, you get the full title or ownership of the home, and the home is yours free and clear. You own your own little corner of the American Dream.
And you get to mow its lawn.
This type of mortgage can come with some surprises. At first, it looks just like your old buddy the fixed rate mortgage; you get an amortization period (or a number of years you're going to be getting a bill from the bank), an interest rate, and a monthly amount you're going to be charged.
But unlike a fixed rate mortgage, the rate on your ARM can change. Your first rate is going to be based on current interest rates and will generally beat the fixed rate mortgage. But as time passes, this mortgage can become a fast frenemy. If market conditions change, so can your interest rate. And let's be honest, how likely is it that the cost of your mortgage is headed down? If the new interest rate is high, you might have to extend the length of your mortgage or dig deep into your pocket (past the lint) to find the money.
Maybe that monthly payment on your mortgage looks really high. Well, a Negative Amortization Mortgage might be the solution. This type of mortgage allows you to pay less than the minimum interest amount each month.
Sound too good to be true?
Well, the debt doesn't just disappear; it gets added on to the total amount you owe, and eventually the bank will want you to start paying a more traditional mortgage amount. The idea behind this type of loan is that it's meant to be more flexible. If you do seasonal work or get paid in big chunks (after the book becomes a best-seller or you land that movie role), you can pay less one month and eventually pay more.
These mortgages are popular with the elderly because the rates are so low and interest in paying off the loan might not be as much a worry as saving money now.
If you serve overseas, it can be hard to buy a house. You move a lot. You're out of the country a lot. The pay isn't always that high.
The Department of Veteran Affairs helps out by offering VA loans for homebuyers who have served their country. You don't need a huge down payment (in some cases you don't need one at all) and the rates are good. You also don't need to jump through as many hoops to get one of these loans.
Yeah, it's the least we can do for the men and women who serve this country.
Balloon and Interest-Only Mortgages
These mortgages at least sound fun, but they can have some drawbacks. At first, they require you to only pay back a low monthly amount because you're only paying interest on the loan.
But after a fixed time of making low monthly payments and living the good life—whamo!—the whole loan is due. Panic city.
At that point, you either have to pay off the rest or look for another loan.
How to Decide
So, which mortgage is the best?
A lot depends on you. If you have a fairly stable job with a good income, a fixed rate mortgage may be nice because what you see is what you get. You don't have to worry about spilling a latte all over yourself because the bank sends you a letter demanding tens of thousands of dollars all at once.
Then again, if you're just starting out and expect to have a fabulous career in rocket science or rapping (or you have plans to become the first astronaut with a platinum record), you might want to enjoy low payments now and pay more when those concerts sell out and you return from the International Space Station. Just have a back-up plan. We hear that talent scouts are really picky these days—and not much rhymes with Apoapsis.
No matter what type of loan you pick, make sure that it's something you're comfortable with in the long term. It may last longer than every other relationship you've had.