Types of Home Loans: Types of Mortgages Available
The types of home loans that may be available to you differ widely. If you are asking yourself “Should I refinance my home” you may also want top know the types of mortgages you can get, and that may help answer the question. There are many different types of home loans, so it often makes sense to engage your broker or bank in a conversation about which one would fit your unique situation. It is also often prudent to talk to a “neutral” finance professional as well, because there could be future implications on your finances and tax situation of which of the types of mortgage loans you choose.
One way or another you should know the types of mortgage loan programs available so that you can choose the best fit for you.
Types of Mortgages
The following are the major types of mortgages loans and definitions:
Rate and term types of home loans
By far the most popular of the types of home loans, rate and term is exactly as it sounds – refinancing to get a better rate and possibly a new term (length in years). Rate and terms usually put you in the same general types of mortgage loans as far as whether it is a fixed rate or not, but at a better rate or shorter (or perhaps longer if you are trying to lower your monthly payments) term than before.
No cost types of mortgage loans:
A subset of the rate and term types of mortgages, no closing cost loans do bring some differences in many cases. The most important aspect that you should pay attention to is whether your no closing cost mortgage cost you anything in the rate you received – sometimes you pay more in a higher home mortgage interest rate to get the lower costs than you would just paying the closing costs up front.
Assumable types of mortgages
These are not actually specific types of mortgage, but more “regular” types of home mortgages with a powerful clause: If you sell your home, the buyer can assume the rate and term of your mortgage. Assumables are a great option for those who get a great rate but think they might sell in the relatively near future. Being able to pass along a favorable rate could increase the resale value and potential of your home.
Interest-only Types of Mortgage Loans
These types of mortgages have fallen out of favor recently given the precarious position these can put a homeowner in if they are kept for many years. Basically, interest-only types of mortgage loans leave you with no equity in your home unless it appreciates a lot while you own it. Obviously, as of this writing (early 2009), many people who took out interest-only types of mortgages now have negative equity in their homes because home prices have not risen.
Cash Out Refinance Types of Home Loans
Any time you do a home mortgage refinance for an amount higher than you paid for the house, or higher than the balance, you are doing a cash out mortgage. Usually you can only do this for a higher amount than you paid if your home has appreciated significantly – and even then, beware, because subsequent refinances, even if you are not literally pulling cash out, may be termed “cash out” procedurally. This could weaken your rate or terms in the future.
Part and part types of mortgages:
These loans are a combination of interest-only and “regular” types of mortgage loans. You pay interest only for a time, and then it switches over to a normal interest + principle mortgage. These are relatively new products in the U.S., though they are popular elsewhere.
Home Equity Types of Home Loans
Home equity loans:
Home equity loans are actually secondary to any existing home mortgage and allow you to take a loan equal to the difference between your home’s value and the amount you owe. The equity you have built up on your home is your collateral. The rates on these loans are often fixed, and usually higher than regular mortgage rates.
Home equity lines of credit:
Similar to home equity loans, home equity lines of credit allow you to borrow on the equity you’ve built. However, these lines of credit have variable (though sometimes very low) rates. With a home equity line you can borrow almost like using a credit card – only taking a little at a time.
Reverse Types of Mortgages
These types of home loans create a payment plan where you basically pay less at the beginning and more at the end of the mortgage term as if the burden of paying off the bulk of the mortgage balance is somehow reversed. These types of mortgage loans are popular with those home buyers who feel like they will be able to handle higher payments later on.
These are the the major types of mortgages available right now. Which one you choose when you are buying your home or refinancing may be a simple decision, or it could be quite complicated depending on your situation. It can often be prudent to consult with an independent source, including a financial adviser and/or a tax adviser before choosing a when to refinance and what types of home mortgages to consider.
Lesser Known Types of Home Loans
Two step types of mortgages can give you the benefits of shorter term types of mortgages on a home purchase or refinance, while keeping your payments low like a longer term option. Basically, two-step types of mortgage loans function exactly as they sound, where you get one rate for a specific period of time, often 3, 5, or 10 years, and then another rate thereafter. With two step types of mortgages you might get the equivalent of a ten-year home mortgage interest rate for a while, but take your chances after that either with a new fixed rate that is based on prevailing home mortgage interest rates at the time or an adjustable rate.
With a two-step, even though it has some of the same benefits as 10 year home interest rate types of mortgages, you have to be careful of what that second step will be; you could end up with a rate much higher than what you would have received with a traditional 30 year fixed rate product. Thus, two-step mortgages are not for everyone wondering when to refinance, but could be good for you if:
– Home mortgage refinance rates are high when you take out the two-step mortgage and you think that the initial 10 year rate is a great solution because subsequent 30 year rates will come down.
– You think you will be selling your home during the initial period so you do not mind the possibility of the second part of the term having a high rate.
– You are merely using two-step types of mortgage loans as a hedge – you didn’t want to get a traditional 10 year rate product fearing that the payments would be too high if anything happened to you income, yet you think you still might be able to pay it off in the short-term.
– You just could not afford the home without the lower home mortgage refinance rate combined with the lower payment afforded by the two-step product (This opens a bit of a can or worms that should be discussed with a financial adviser).
Two step types of mortgage loans combine low rates and lower payments, but they carry risks and are therefore not for everyone who is wondering when to refinance. They do work for people in some circumstances and have some of the benefits of shorter term types of mortgages, so they may be worth looking in to.
More About Construction Loans
Many people take out a mortgage loan for a new construction. This is a complicated issue for a bank, since they cannot know for sure what the exact value of the property will be and whether it will be finished on schedule. Unlike providing a mortgage loan for an existing property, or refinancing an existing property, these type of mortgages have more risk and uncertainty. In most cases the new construction will need an original mortgage, but in some cases the loan acts more like a refinance when it is an addition that is being added.
If you are in the market for a construction mortgage loan you should know a few things about how the process will differ from the traditional loan or refinance process. First of all, given the higher risk and uncertainty, the rate will be higher. It may not be much more than a point higher, but it will be very unlikely to be substantially the same as the traditional types of mortgages being offered. Second, there will be a handful of due diligence you’ll need to do to convince the bank that your construction is being well-planned and will be financially worthwhile. And finally, you will face a time limit to get this all done, with most construction loans having a time period attached to the funding.
The biggest difference between a construction loan and traditional types of mortgages, however, is the fact that in most cases the loan will be variable while the construction is progressing and only fixed when it is done. You may or may not know what that fixed rate will be when you start the construction. Construction loans that are more like mortgage refinance loans may be the exception and may be fixed from the start (but again likely with higher rates than traditional refinances).
More About Assumable Mortgages
An assumable mortgage allows you to pass along your loan to someone who buys your property should you sell. This way, if you have favorable terms or a low rate on your mortgage or mortgage refinance, the buyer may be inclined to buy your house. In fact, if the buyer figures s/he will save money in the long run by assuming your favorable mortgage interest rate, s/he may be more likely to pay what you are looking for.
Assumable mortgages are not available everywhere, and only some banks and mortgage brokers use them, but if you are buying a house or refinancing mortgage during a time of low rates and solid terms, you may want to ask around about assumable mortgages.
Let’s say you are lucky enough to have an assumable mortgage. How then do you convince prospective buyers of your home, who may or may not understand or trust what you are saying about your assumable? There are two steps you can take:
- Do the math for them and lay it out cleanly – use prevailing rates, or if they are willing to tell you, the rate they are considering. Calculate the payment they would pay on your assumable mortgage, and then the rate they would pay otherwise. They will see the monthly savings on the low mortgage rate of your assumable!
- Do another piece of math. Use what they are saving to demonstrate how much more house they are getting for their money. With your assumable mortgage they might be getting your 2000 square foot house, where the same payment with a higher rate mortgage will only buy them an 1800 square foot house.
This math might help the buyer see the potential and power of assuming your mortgage rate and terms.
Types of Mortgage and Who They are Best For
Rate and term refinance: The most common of the types of mortgage loans, the rate and term basically means that you are refinancing into a new mortgage rate and sometimes into a new term. Rate and term refinances are fixed rate loans.
Best For: Those who want traditional mortgage terms and predictability, and can get a low rate at the time.
Not for: Those who will move very soon may find that an adjustable rate mortgage may be better.
Assumable 10 year mortgages: While not really one of the types of mortgage loans in its own, an assumable mortgage has a clause that says that if you sell your home he buyer will get your current home mortgage interest rate that you have on your mortgage. Assumable mortgages can actually increase your home’s resale value.
Best For: Those who can get a great rate but know they will be moving sooner than later. This is obviously specially true during times when home mortgage interest rates are more likely to rise than fall.
Not For: Those who are not ever likely to move, or for those who cannot get an attractive rate. There is no reason to have an assumable mortgage if the home mortgage interest rate is no good.
Interest-only Mortgages: If you want complete control over how much you pay each month for your mortgage payment, and particularly if you have a job situation that pays variably, an interest-only loan gives you the option to pay only the interest (and no principle) each month.
Best For: Those who at the time cannot quite afford the interest and principle payment, but who have a financial situation that is likely to improve soon, and also good for those with an uneven financial situation.
Not For: Anyone who can afford to make interest and principle payments, or for those whose financial future is not as certain. Interest-only mortgages can be a problem in later years if principle is never paid down.
Cash Out Mortgages: Any time you refinance your mortgage for more than you owe it is called a “cash out” mortgage.
Best For: Those who have a specific purpose in mind for the money that either increases the value of an asset or purchases a new long-term asset. In other words, if the money would have to spent anyway, and a higher interest loan would have to be used, it’s better to take advantage of a cash-out product.
Not For: Those who merely want more cash on hand, since you will be paying years of interest on this money, even if the rate is low. This type of mortgage is also, obviously, not for those who could have trouble affording the new higher payment that comes with the extra cash out amount.
These are four of the major types of mortgage refinance you could get. Some, like assumable mortgages, may not be available everywhere. Others, like interest-only mortgages may be hard to qualify for. While the above is meant as a guide, you should consult with a financial advisor and/or a tax advisor before choosing one of these products if the choice is not simple.
Shorter Term Types of Mortgage Loans
Shorter term mortgage rates are often lower that 30 year interest rates and therefore hold an advantage for those who can afford that higher payment.
Advantages of Shorter term types of mortgages
– 15 year mortgage rates are lower than those for a traditional 30 year fixed rate types of mortgages. While there is no guarantee and there can be financial environments where this situation is flipped, 15 year types of mortgage loans are usually lower. How much lower? While an average would not be a meaningful number, at the time of this writing the difference between a fixed 30 year and fixed 15 year mortgage rates is in the 1% range.
– You build equity in your home much faster. Because more of your monthly payment is going toward principle, and because you are generally paying down that principle 3 times faster, 15 year types pf mortgage loans give you equity in your home much more quickly. Soon you will find that you fully own a higher percentage of your home than you would otherwise.
– You pay less interest. 15 year types of mortgage loans come with far less interest paid to a bank than a 30-year product. Use any one of a number of online home mortgage interest calculators to see this for yourself – you may be amazed by how much more is going toward paying down your home loan and how much less is going to interest.
Disadvantages of Shorter Term Types of Home Loans
As we’ve said in previous posts, there are drawbacks to shorter term home mortgages too. First and foremost you have to make sure you can afford the higher payment for the full 10 years or until you sell. But the above advantages may be highly compelling as you consider your choice. Then again, there are also disadvantages to 15 year mortgage rates, so they are not for everyone. The main potential drawbacks are:
1. Much higher monthly payments. Use a mortgage calculator and you’ll see that despite the fact that you get a lower home mortgage refinance interest rate in most cases, the payment will be much greater.
2. You may be able to afford your short-term loan now, but your financial situation could change. By taking out a short-term mortgage you are betting on being able to meet the higher payments for the whole term. If something changes you might either have to refinance into a longer term home mortgage interest rate at a time when rates are not favorable, or even potentially default.
3. The difference in 15 year mortgage rates and 30 year mortgage rates may not offset the above factors, and you can always pay off your 30 year rate mortgage more quickly anyhow. The actual savings between these two types of loan fluctuate, and you also have to consider what the actual savings are after any tax benefits you receive. It may be that there is just not enough savings to take the risks in #s 1 and #2.
These are the drawbacks, or at least the challenges you face when taking out a 15 year mortgage. They may or may not be enough to dissuade you from the choice of when to refinance and what product to choose, but you should at least be aware of them.
You can follow the today’s 15 year mortgage rates on Zillow
Types of Home Loans Summary
A major part of the process of choosing the best loan for you is to know the types of mortgage loan programs available. We hope that this page and others that also have the types of mortgage loans and definitions will prove helpful. Best of luck as you research the types of mortgages available and what might be the best types of home loans for you. Please feel free to share information you gather about the best types of home loans.