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Mortgage: Understand the Different

Mortgage Types Available

Mortgage is a term commonly used by people when discussing home loans. They assume that it is a monolith but become overwhelmed by sheer number of choices and options when they go to a lender to avail a loan. Most people think that they need to somehow get the cheapest rate of mortgage and that is all that they should be concerned about. They do not know how to react when they hear prefixes that are used by loan manager when talking about mortgages. Here is an overview of various types of mortgages with their pros and cons to help you take an informed decision.

Fixed Rate Mortgage

As the name suggests, rate of interest remains the same during the tenure of the loan (usually 1-5 years). There are lenders who are willing to provide fixed rate mortgage for loans up to 10 year term. With this kind of mortgage, you have peace of mind knowing your monthly repayments and the total amount of money you have to repay.

Advantage

You continue to pay the rate agreed upon even if the market rate goes up. This can help you save a lot of your hard earned money over a period of time.

Disadvantage

You remain tied to the fixed rate of interest and cannot get it lowered if market rate falls as the lender charges a heavy penalty for changing the mortgage. It pays to know for how long the rate of interest is going to be fixed before agreeing to fixed rate mortgage.

Variable mortgage

This is a type of mortgage where the rate of interest is floating and changes as the market rate changes. This means your EMI goes up and down with changing rate of interest. It is also called adjustable rate mortgage (ARM) where mortgage rate adjusts itself according to the bank rate.

Advantage

You have the peace of mind that you are not paying higher or lower rate of interest that what is prevailing in the market.

Disadvantage

You do not know when your EMI is going to change and thus have to prepare accordingly.

Capped rate mortgage

This is a type of mortgage where there is a cap or ceiling placed over your EMI and it cannot go higher than this cap even if the market rate goes higher. You have the comfort of knowledge that your repayment will never go beyond a maximum limit. It is a good arrangement for you if you believe mortgage rates are going to become too high in future.

Government insured vs. traditional loans

In addition to mortgages that are fixed or adjustable, there are also loans that are backed by government agencies. Mortgages that do not have this government backing come under the category of conventional loans.

There are several types of loans with government backing. These include:

Federal Housing Administration(FHA)
Veteran Affairs (VA)
United States Department of Agriculture (USDA)

These loans provide government assurance to lenders against losses in case of default by the borrower. FHA loans are available to all types of borrowers while only those who have served in US Military and their family members are eligible to apply for VA loans. USDA loans are provided to rural residents who are either dependent upon agriculture or make a living from other sources in rural areas. All other loans that do not come with government backing are termed as conventional loans.

Government insured vs. traditional loans

This is another type of loan that is dependent upon the size of the loan or the amount of money that you are borrowing from the lender. Most people remain unaware about this term even after availing a mortgage loan from their lender. There are two government controlled agencies called Fannie and Freddie. These agencies buy mortgages from banks and then sell them to private investors. They do not buy individual mortgages but mortgage backed securities (MBS). A conforming loan, according to these agencies, is one that falls below the maximum size prescribed by them or otherwise one that fulfils all their criterion.

Jumbo loans

These are the loans that exceed the limit for conforming loans set by Freddie and Fannie. Lenders are at a larger risk when giving jumbo loans to borrowers. Therefore Jumbo loans carry a higher mortgage rate. These borrowers are also asked to make larger down payments to their lenders to cover some of the risk.

This is a brief overview of different types of mortgage loans available to you in the market. You must do your research to find out as much as you can about different options available to you before availing mortgage loan. By shopping a mortgage in a clever manner, you can get down to the best mortgage rate and also pay back your loan in easier terms and conditions.