These mortgages, with a fixed percentage rate, and a fixed loan amount are usually carry higher rates than other types of mortgages, but they offer the security and certainty of knowing your monthly payment and interest rate will never change.
These mortgages (also known as ARMs) have a variable interest rate and monthly payments that are recalculated on a regular basis to reflect changes in the market interest rate. These rates are typically lower than the rates in fixed-rate mortgages, but expose you to the risk that market interest rates may rise in the future.
A Balloon Mortgage has a fixed-interest rate and payment, but the term of the payments is only five to seven years. After this time, the entire balance of the loan becomes due. If you don't have the money to pay back the loan after the initial term, and you can't get another mortgage, you're stuck.
Balloon Mortgages are typically used as a last resort by those who can't qualify for a fixed- or adjustable-rate mortgage. They also are used by those who may have the assets to pay for a home outright, but want to avoid liquidating those assets because they may be providing a higher return on investment than the percentage rate of the loan.
Fixed Rate Mortgages
The basic, tried-and-true, no-surprises mortgage is the Fixed-Rate Mortgage. Your monthly payment is the same, every month of the entire length of the loan.
- You can rest assured your rates won't go up, and your payments will stay the same.
- They typically have a higher interest rate. The lenders are assuming the risk that the market rate may go up, and you'll be locked in at a lower rate. As a result, these types of mortgages have a premium for offering the security of the fixed rate.
- They are harder to obtain. Since your interest rate, and hence your initial payments, are higher than another type of mortgage, you won't be able to borrow as much as you could with another type of loan.
Common Fixed-Rate Mortgages
The 30-Year Fixed-Rate Mortgage
With 30 years to pay off the loan, these loans allow you to borrow more money for the same monthly payment than shorter loans. They may also make it possible to have a lower down payment, because the down payment will affect your monthly payment less.
The 15-Year Fixed-Rate Mortgage
With 15 years to pay off the loan, these loans may require a higher monthly payment and down payments than their 30-year counterparts, or are suitable for lower-priced homes. If you can make a higher down payment, or can afford a higher monthly payment, or the value of your home puts your monthly payments into your budget range, a 15-year Fixed-Rate Mortgage may be for you. Since the term of the loan is half as long, you can make significant savings on the total amount of interest paid on the loan.
Adjustable Rate Mortgages
ARMs allow you to fix the interest rate for the length of time that you plan to hold the loan without paying extra for interest rate protection you don't need.
- They typically have a lower interest rate. Since the lender is assuming less risk on the possibility of interest rates going up, they offer lower interest rates, which translates to a lower monthly payment on a similar term fixed rate mortgage.
- The initial rate on an ARM is fixed. The shorter the initial fixed period, the lower the initial rate can be.
- You can borrow more with an ARM than a Fixed Rate Mortgage. If you're just outside the range of your dream home, an ARM can make all the difference.
- Your interest rates may go up. If the market takes a turn for the worse, or you keep your mortgage longer than you intended (that is, you decide to stay in the house longer than the initial fixed interest rate, instead of selling the house and the mortgage to another buyer), you may be stuck with larger payments. In other words, if you initially plan to stay in the house you're buying for five years, and get a loan with a five year fixed initial interest rate, and you end up staying longer, your interest rates may rise if the market rates go up.
The 10 in 10/1 indicates the length of the fixed initial rate out of 30 years, and the 1 indicates that the interest rate is readjusted annually for the remaining length of the term (in this case, 20 years).
The initial interest rate is locked for 7 years, and then annually adjusted for the remaining 23 years.
The initial interest rate is locked for 5 years, and then annually adjusted for the remaining 25 years.
The initial interest rate is locked for 3 years, and then annually adjusted for the remaining 27 years.
1 Year ARM
A 30-year loan with an interest rate and monthly payments that adjust annually.
6 Month ARM
A 30-year loan with an interest rate and monthly payments that adjust every six months.
The shorter the initial rate is, the lower your initial monthly payment will be, but the higher your highest possible monthly payment will be as well.
Similar to a 30-year fixed rate mortgage, balloon mortgages have a fixed rate and payment. However, after the five- or seven-year term, you have to repay the entire loan balance.
- It is easier to qualify. Since the loan is effectively a short term loan (no more than seven years) the lender is taking less risk, which makes it easier for you to qualify for it.
- It gives you five to seven years of protection from rate increases.
- Since it is relatively less risk for lenders, they are willing to lend more for balloon mortgages. If you can barely afford your dream home, this can make all the difference.
You must refinance your mortgage, sell your home, or pay the remaining amount of the loan after five or seven years. This means one of three things:
- If you decide to refinance your mortgage, and the interest rates have gone up, you'll end up with a higher interest rate. In this scenario, you may have been better off with a 10-year ARM or a Fixed-Rate Mortgage.
- If you sell your home, and the housing market has taken a turn for the worse, you may not be able to get enough out of the sale of your home to pay off the remaining amount of your debt.
- You will have to come up with a large sum of money if you decide to pay the remaining amount of the loan (after five or seven years) without refinancing or selling your home. Most people who apply for balloon mortgages have a difficult time qualifying in the first place, so it may be difficult to refinance the home when the balance is due, leaving them in a serious bind.
Common Balloon Mortgages
A loan with a fixed interest rate and monthly payment for five years. After that, the balance of the loan becomes due in one "balloon" payment.
A loan with a fixed interest rate and monthly payment for seven years. After that, the balance of the loan becomes due in one "balloon" payment.