I am not a realtor, mortgage broker, or loan officer. However, I did recently buy my first house. Feel free to liberally sprinkle the following with “I think”, “as I remember”, or “in my understanding”.
Fixed rate mortgage, aka a “traditional mortgage”. The interest rate you get with this will never change, so your first monthly payment will be identical to your last (barring rounding adjustments). These are usually 30 year, although 15 (and maybe even 10) are also available.
Adjustable rate mortgage, or ARM. The interest rate will change over the course of the loan. Different banks use different “indices” to adjust the rate, some with sharp changes and some with more gradual ones. These may also have a “lock” period for a period of time before the rate is changed for the first time. They generally have a lower interest rate than fixed-rate mortgages, because the bank is hedging on the rate increasing in the future. If you’re wanting to keep the house for an extended period of time (more than 5 years or so), this probably isn’t as good a deal as a fixed rate. Interest rates are probably “bottomed out”, so the rate can only go up if it’s adjustable. (again, I’m not a loan officer, economist, or bank employee, so take this as a WAG).
Interest-only loans. AFAIK, these are only features of ARMs. Basically, the monthly bill you get only requires you to pay the amount of interest accrued over the past month. You’re paying slightly less, but the amount of principle (what you owe the bank) never goes down unless you overpay.
Negative amortization. I commonly hear radio ads for something like “1.5% interest mortgages”. With offers like that, why should you get a fixed-rate at 5.5 or 6.0%? Well, I never really dug into the details, but I strongly suspect that the bill you get only requires a payment covering 1.5% interest (along the lines of an interest-only loan), but the amount owed still grows at 5.5 or 6.0% interest. So while you’re paying much less to the bank per month, your debt is growing instead of decreasing. This might be something useful for people with variable income (say a contractor who pays down the principle when they have work, and pay the minimum when they’re between jobs) or a refinance option for someone who needs some time to get back on their feet after a financial setback, but probably wouldn’t be the best choice for someone on a dependable regular salary.
Mortgage Insurance. Banks want some assurance that a chunk of the mortgage is going to be paid. So until the principle is paid down to 80% of the house’s value, you are required to take out mortgage insurance on the loan. I’m not sure how the premium payment is calculated, but on my $200k home, roughly $170 of my mortgage payment is for the insurance.
If you don’t have the cash to make a 20% down payment, you can get around having to pay mortgage insurance by getting an 80/20 loan package deal. Basically you get a primary loan for the amount of the house, then take out a second loan to pay off 20% of the first loan when combined with your down payment. The second loan is completely independent, with different interest rate (almost always higher), possibly different loan duration (15 years vs. 30), ARM vs. fixed-rate, and quite possibly with a different bank. When I was first running numbers with my loan officer, the total monthly payment with two loans came out roughly equal to one loan + mortgage insurance, but part of the second payment does go into the house’s equity, rather than being completely “flushed away” paying the insurance premium.
Home Equity Line of Credit (HELOC). This seems to be a common choice for a second loan. It was explained to me as something like a credit card balance that has been maxed out. Your payments bring the balance down, but you have the option to “charge” to it as well, up to the credit limit established when you set up the loan.
It’s generally a good idea to put down as large of a down payment as you can. This will reduce the amount of the loan (and the monthly payment), and can reduce (or remove) the amount of time you’re paying mortgage insurance. As a possibly useful tip: I heard that you can withdraw from an IRA account with no penalty or taxes if you are using that money for a down payment on a home (possibly only for first-time homebuyers). Obviously check with a financial advisor or tax accountant for details.
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When I was working on chosing a loan package, I always kept the attitude that anything pushed hard by a bank was always in their benefit. Well, any loan is ultimately going to be in their benefit (they’re not a charity, you know), but more so for the big promoted stuff. I also had a loan officer I knew and trusted, and I made sure to go over the various pros and cons of the different available types.
For my situation, I ended up getting a single, fixed-rate, 30 year mortgage with 5% down payment. Due to some constraints due to the property* I couldn’t get a second loan with good enough numbers to justify the payment vs. the mortgage insurance. I have a stable, well-paying job (the mortgage payment works out to roughly 36% of my take-home pay), and as my new budget shakes out over the next month or so I’ll be overpaying the loan somewhere between $100-$500, which will reduce the loan period 5-15 years.
- It’s a “manufactured” home, which is considered a higher risk by banks. Some won’t offer loans for those types of properties, and loan options are more limited.
Oh, and if you want to play with numbers, I’ve gotten a lot of use out of the mortgage calculators on this site. Just remember that those only cover payment to the loan, your actual monthly payment will also include property taxes, house insurance, loan insurance, and maybe one or two other items I’ve forgotten.
) and ability to make the place truly my own with my own hands.