The mortgage market offers a variety of mortgage loans catering to the needs of homebuyers and investors. The titles and details of these loans can become confusing, especially as new types are introduced continuously. You can make sense of these loan types if you understand the basic principles that govern most mortgage loans.
Basic Principles of all Mortgage Loans
- The home is used as collateral to back up the loan. A lender can force the sale of the home if the borrower defaults by failing to make scheduled payments.
- The larger the loan compared to the value of the home, the riskier for the lender and, often, the more expensive the loan will be.
- The monthly payment is usually a bit larger than the interest due so that some of the loan principal is repaid with each payment. This process is called amortization and is why most mortgage loans can be retired when all the monthly payments have been made.
All mortgage loans have one of the following features:
- Fixed Rate – 15, 20 and 30 year terms are the most common for fixed rate mortgages. The benefit is that your mortgage payment stays the same for the life of the loan.
- Variable Rate – also known as an ARM (adjustable rate mortgage). The benefit is that you can start out with a lower payment, but it may increase over time.
As you learn more about the types of financing available, you will notice that some loans appear to have more favorable terms. That may indicate that those loans are, indeed, bargains (and it does pay to shop around), but usually it means that those loans could have some feature that is less appealing to borrowers. For example, shorter-term loans often have slightly lower interest rates compared to longer-term loans. However, the monthly payment for the same amount of principal may be higher because of the shorter term. Variable rate loans usually have much lower interest rate for a set period of time but rise in the future.