Financing a home is a famously tricky process, fraught with complexities and risks that are difficult to detect from the outset. During real estate booms, lenders are prone to offer homebuyers fancy payment programs with strange terms in hopes of enticing them. This kind of maneuvering helped spur the famous real estate meltdown in 2008 that led to economic recession and financial panic throughout the U.S. While lenders have gotten smarter and safer since then, it still requires a ton of patience and care to find the right financing plan for you and your family. Let’s look at three of the most common mortgage loans that you may want to consider when buying a home.
1. Fixed-Interest Plans
A fixed-rate home loan means that your interest figure remains constant for the entire duration that you pay it back. This type of loan is “amortized” over its lifespan. This means that lenders take the principal amount of your loan, add it to the interest that will accrue, and then split this total sum evenly into monthly payments. In most cases, these payment plans are “front-loaded,” which means that a higher percentage of your early payments go toward the interest sum than toward the principal. Fixed loans are most commonly paid over a thirty-year period, but it takes some careful consideration to determine the right balance between loan duration and interest. You may be attracted to a forty-year payoff with a lower rate, only to find that this program will be more expensive in the long run.
2. Adjustable-Rate Plans
Unlike fixed plans, adjustable-rate mortgage loans, or ARMs, have rates that change periodically. Though this may sound unnecessarily complex, ARMs can be very attractive depending on your personal finances and the borrowing market’s climate. If fixed loan options have especially high rates, ARMs can be the best way to save. Lenders create these plans based on an index number, which is essentially a measure of money’s current value. Since currency is susceptible to inflation, ARMs allow lenders to respond to this volatility by increasing the figure by a specified margin after a certain period of time. For example, you may agree to an ARM with a low rate that remains fixed for the first five years. After this period, the lender may up the figure by a few percentage points. Don’t worry: ARMs always involve a cap, which prevents rates from jumping too high.
3. Interest-Only Plans
Interest-only mortgage loans are usually the preference of homebuyers who borrow on a tighter budget. They are unique because they allow the borrower to make payments only towards the interest for the first few years. This allows buyers to make lower payments at first. However, the figure may be adjusted after this first period, leaving the borrower to start making payments. In this way, these plans are hybrids of fixed and adjustable mortgages.
Mortgaging your home can be frustrating and difficult, but knowing these basics before you sign anything will help you immensely. Look at your financial profile and where you see your life heading in the coming years, and find the program that most suits your needs.