The Ultimate Guide to Understanding Mortgages

Chances are your home is by far the largest purchase you’ll ever make.

So, knowing how to decipher the language of loans and mortgages is key for any homeowner. Get a handle on your finances and better manage your budget with this helpful overview of loan types.

Feeling lost in the sea of home mortgage loan options? You’re not alone. We’ve taken the guesswork out of picking the best lending option for you by outlining the main home loan types. Happy house hunting!

Fixed Rate:

Fixed-rate loans dominate the market more than ever right now, and for good reason: they’re cheaper than they’ve been in three decades. The percentage difference between variable-rate and fixed-rate loans has narrowed, too, and the spread usually isn’t enough to justify giving up all those years of fixed-rate security.

Long-term, fixed-rate loans are good for people who can comfortably qualify for the loan they want and who expect to stay in their homes for many years. But how long do you pay? Many baby boomers are now refinancing mortgages with 15-year fixed-rate loans, assuming they’ll make their last payments by retirement.

Adjustable-Rate Mortgage:

Borrowers who are willing to sacrifice the long-term security of a fixed-rate loan can get a lower interest rate and start with lower payments if they take an adjustable-rate mortgage (ARM). That’s a particular benefit for two types of borrowers: those who expect to move within five years, and those who may want the slightly lower rate to help them qualify for the loan that puts them into the house of their dreams.

ARM borrowers, however, sacrifice simplicity. The interest rates on these mortgages rise and fall along with market interest rates and, if you’re not careful, you can find your monthly payment rising higher than you can afford. Several variables determine whether an ARM is a good deal. Here are the most important ones:
  • Your Index
  • Your Frequency
  • Your Rate Cap

Variations

What if you have a steady income but little down-payment cash? Enter Fannie Mae, the nation’s largest source of home mortgage funds. It buys mortgage loans and creates new products designed to keep money flowing into the mortgage market.
Fannie Mae’s “Flexible 97” mortgage allows borrowers to limit their down payment to 3 percent of the cost of their home, and—unlike most lending plans—to get that 3 percent as a gift from parents, employers, or other family members.

This is just one of many loans on the market today aimed at putting buyers into homes. Borrowers who have cash flow but little or no savings, savings but no cash flow, poor credit ratings, and other special situations can find their own best mortgages by checking the following types of loans:

Balloon Mortgages:

These loans often carry monthly payments as low as those of 30-year mortgages, but they’ll usually come due for payoff in five or seven years.

These can be great loans for homeowners who know they won’t be staying put, but who like the certainty of a fixed rate. They’re risky for someone who stays in a home beyond the term of the loan, because then the homeowner will need to find a replacement mortgage, move, or make that big balloon payment.

Hybrids:

When you cross a balloon mortgage with a fixed- or adjustable-rate mortgage, you get a hybrid. These loans stay fixed for five or seven years, then convert to either fixed-rate or variable-rate mortgages. They have lower rates than fixed-rate mortgages but carry the risk of having the last 25 years of the loan being an unknown.

Again, they’re good for people who like fixed payments, who need wiggle room on the rate to qualify for the loan, or who expect to move before the fixed part of the loan expires.

Low-Doc and No-Doc:

“Doc” stands for documentation. If you’re self-employed or have a complicated financial situation, you might shoot for one of these loans, especially if you’re in a hurry to get into a particular house or if your income is rising rapidly.

Instead of asking for tax returns, business statements, and other paperwork a borrower might be expected to provide, low-doc lenders are willing to make the loan fast and easy. But it comes at a price—maybe one-half percent more, or even a full percentage point.

These loans are for borrowers with good credit ratings who are shopping for loans worth 75 percent or less of the home’s value and are willing to pay higher rates in exchange for quick-and-easy approval.

We have answers to your mortgage questions

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