5 Types of Mortgages: Choose the Best Home Loan For Your Real Estate Purchase
Most people who want to buy a home will need to save for a down payment and apply for a mortgage to pay for it. There are several different types of mortgages, and buyers should ensure they understand the terms. Some mortgages provide a lot of flexibility, while others prioritize predictability. With this information, buyers can distinguish between the common mortgage types and determine which one will be best for them.
The mortgage payment that borrowers can expect depends on a few factors. These include:
- Interest rate
- Amortization schedule
The payment remains the same for the entire loan duration, but the interest rate plays a heavy role in how payment is applied. A mortgage with a variable rate can fluctuate over time, meaning the amounts applied to principal and interest can change. When interest rates are higher, less money is put toward the principal. If interest rates drop, more of the payment goes to the principal. Some variable-rate mortgages set a cap on the maximum interest rate that can be charged.
A fixed-rate mortgage offers a higher degree of predictability than a variable-rate mortgage. Specifically, a fixed-rate mortgage means that the mortgage's interest rate is set at the beginning of the mortgage and will not change until the end of the term. The interest rate will not rise or fall, as it would with a variable-rate mortgage. For many borrowers, this convenience allows them to plan ahead. They should remember that they may end up paying a higher rate than the prime rate if rates drop.
An open mortgage offers flexibility, usually in exchange for a higher rate. Open mortgages do not limit the amount of money borrowers can contribute to the principal. Borrowers who are planning to pay off the loan quickly, or expecting a windfall that they can use to pay down the principal significantly, might prefer the convenience of an open mortgage. The higher interest rate may make it less ideal for people who only intend to make regular payments every month.
A closed mortgage assures borrowers that they can keep the same terms for the life of the loan. As a general rule, closed mortgages have a fixed rate that may be lower than an open mortgage. The lender sets limits on the prepayments that borrowers can make. Typically, they will cap the number of prepayments each year (if they allow prepayments at all). Borrowers planning to stay in the home for many years may find the predictability of a closed mortgage ideal.
Sometimes, the best terms for the beginning of the mortgage are not quite what the borrower seeks to have for the duration of the loan. In this case, a convertible mortgage may make the most sense. A convertible mortgage starts with a set of features and a short term, usually less than a year. For example, a variable rate mortgage may have a 12-month term. Once the term is up, the borrower may be able to choose to convert the loan into a fixed-rate mortgage or continue with another short term. It is common to start with an open convertible mortgage, shifting to a closed one after the initial term.
Choose The Best Loan For Your Home Purchase
Borrowers can consider many types of loans, and they should research each before applying for a mortgage. The best way to prepare for a move to your new home is to select the right financial vehicle to get you there. Depending on personal and economic factors, the right mortgage might change over time. Using this information makes it easier for buyers to identify the best loans for their financial goals.