A mortgage is a loan that you obtain to close the gap between the cash you have for a down payment on a home and the purchase price of that home. There are a number of mortgage loans to choose from. It’s important for you to understand the pros and cons of each so you can know which option will work best for your budget.
FIXED RATE MORTGAGE
With a fixed-rate mortgage loan, your interest rate will never change, regardless of what the economy does. You can get this fixed rate mortgage usually in 10, 15, or 30 year terms. So your monthly mortgage rate will not change throughout this term. The only con to this loan is that you’ll pay a premium for this predictability in the form of a higher interest rate. When the lender grants your fixed rate loan, they take a risk. If the prime interest rate increases during this loan, the lender will have to pay the difference. This option is good for the home buyer who wants to know how much their house payment will be every month.
ADJUSTABLE RATE MORTGAGE (ARM)
Adjustable rate mortgages, or ARMS, have interest rates that adjust periodically during the life of the loan. Most ARMs begin with a fixed rate for an initial period of time (often 3, 5 or 7 years). During this introductory period, the rate is fixed and won’t change. However once this period ends, the loan will convert (increase or decrease) to an adjustable rate based on the market. The rates are usually lower than a fixed mortgage because the buyer is assuming a lot of the risk. The con of this loan is that you can never predict the interest rate. However, if you enter into this type of loan due to financial status, you can always refinance prior to the end of the introductory period (before the rate changes) and hopefully secure a more stable rated loan.
A balloon loan begins with a fixed interest rate for a set number of years. But unlike traditional fixed-rate mortgages, the interest rates on balloon loans are nearly as low as those found on adjustable rate mortgages (ARMs). However, the problem is the term. The initial fixed-rate period is usually 7 to 10 years. Following this period, you have to pay off the loan's remaining balance in full. So the homeowner must be prepared for this very large payment, or refinance their balloon prior to the end of this period. This is a good mortgage option for those who want to live in the property more than the life of the loan, want to pay the mortgage off quickly, like stable monthly payments, or plan to move before the life of the loan, in which the loan can be assumable and passed to another buyer.
Mortgage refinancing is when you replace your existing mortgage loan(s) with a new loan, usually secured by the same assets. The most common type of refinancing is for home mortgages.
The main goal to refinancing is to lower your monthly payment or reduce your payment period. However you should note that many types of refinancing options contain penalties for early payments as well as closing and transaction fees. So you’ll want o make sure that these extra fees do not offset the savings you’d get with the refinance.
HOME EQUITY LOAN
A home equity loan or second mortgage loan, allows a homeowner to obtain a loan by using the equity built up in the home as collateral. The equity consists of whatever funds the homeowner has invested in the property. A home equity loan is a fixed rate loan with terms generally ranging from 5 - 15 years.
A single lump sum payment is issued by the lender to the borrower which is then repaid over a set period of time at an agreed upon interest rate. The payment and interest rate remain the same over the life of the loan.
Home equity loans also have special tax advantages. With a home equity loan, homeowners can borrow up to $100K and still deduct all of the interest when filing tax returns.
You can use a home equity loan calculator to check what various home equity loan rates will mean for your monthly payments. Always compare offers from several lenders and brokers to obtain the lowest home equity rate possible.
Home-equity loans can be valuable tools for responsible borrowers. As long as you have a steady, reliable source of income and know that you will be able to repay the loan, the low interest rate and tax deductibility of paid interest makes this loan a very sensible alternative. Fixed-rate home-equity loans are especially good to help cover the cost of a single, large purchase, such a new roof on your home or an unexpected medical bill. And the HELOC provides a convenient way to cover short-term, recurring costs, such as the quarterly tuition for a four-year degree at a college.
HOME EQUITY LINE OF CREDIT (HELOC)
More and more financial institutions are offering home equity lines of credit. By using the equity built up in your home, you may qualify for a sizable amount of credit, available for use for anything and at an interest rate that is relatively low. Also, under the tax law and depending on your specific situation, you may be allowed to deduct the interest because the debt is secured by your home.
With a home equity line, you are approved for a specific amount of credit, the maximum amount you may borrow at any one time under the plan. Many financial institutions set the credit limit on a home equity line by taking a percentage of the home's appraised value and subtracting the balance owed on the existing mortgage. Most plans are set at a fixed period during which you can borrow money such as 10 years. At the end of this period, you may choose to extend the credit line if the plan allows. Depending on the plan, there may be limitations of use. Some plans might require you borrow a minimum amount each time you draw on the line and to keep a minimum amount outstanding.
HELOCs typically are based on variable rates rather than fixed rates, so your monthly payment may change. If you sell your home, you will likely be required to pay off your line in full immediately. If you are likely to sell your home in the near future, consider whether it makes sense to pay the up-front costs of setting up a line of credit.