Last week, I discussed some of the most common types of mortgage programs. This included conventional, FHA, and VA, and I touched on construction, or rehabilitation, loans. These are definitely the most common ways people finance a house, and each targets a specific part of the housing market. Today, I will discuss the most common methods of payment for a mortgage. These are fixed rate and adjustable rate mortgages (ARM).

Fixed rate mortgages are the most traditional mortgage type. You tell the lender over what period of time you would like to repay the loan (generally 15, 20, or 30 years), and the lender creates an amortization table (payment schedule) based upon that timeframe. If you make all of the payments on time, you pay off the loan and all interest in your timeframe. You can directly impact your interest rate and monthly payments by changing the period of time you repay the mortgage over. You can also pay the mortgage off quicker by making additional principal payments, assuming the loan does not have a prepayment penalty.

Adjustable rate mortgages seem to come in and out of favor based upon prevailing rates. Right now they are very popular because you can borrow money for almost nothing with an adjustable rate loan. Adjustable rate loans offer interest rates that are lower than fixed rate loans, and generally offer a specific lock period (1, 3, 5, 7, or 10 years). But after that lock period, the rate will change every year based upon then current rates. So if rates go up 3% during your lock period, your interest rate would go up by 3%. So while this option is great in the short term (less interest), it can be a gamble for a borrower looking to pay off a home they bought over 30 years. Adjustable rate mortgages also offer multiple payment options; there is usually a fully amortized principal and interest option, as well as an interest only option. So it is great for people with fluctuating income, because they can pay less in months when they have less income and more in months where the income is higher (sales jobs, for instance).

Either repayment option will get you to a place where you own a home, and either will eventually leave you debt free, but which one is best for you depends upon your expected timeframe in the house, your tolerance for risk, and your income. On Thursday, I will talk about which combinations of programs and repayment options are most popular, and why.

If you have any questions about the difference between fixed and adjustable rate mortgages, please contact me. If you would like to add anything about these mortgage options, please leave a comment.