Types of Mortgages

There are many types of mortgages you can choose from. Which type you choose usually depends on the length of time you think you'll be in your home or the other financial obligations you have. If you think you'll be there for the long haul, then you may want a fixed rate mortgage with the lowest interest rate you can get.

There may be other considerations, however. What if you have kids who are going to be entering college in 10 years? In that case, you might consider getting an adjustable rate mortgage, or a mortgage with a balloon payment so you can keep your payments low for the first few years in order to save for college. Once the kids are out of college, you can refinance at the current rate. If you don't think you'll be in your home for that long, then you may also want to look at other options.

Here are some of the choices you'll find in mortgages:

Fixed-rate mortgage

This mortgage offers an interest rate that will never change over the entire life of the loan. If you lock in a rate of 7 percent that calculates a payment of $1,247 per month, then you know that in 20 years you'll still be paying $1,247 per month. The only things that will change will be the property tax and any insurance payments that are included in your monthly payment.

The length (known as the term) of your fixed rate mortgage can be 15, 20 or 30 years. These terms have an affect on the various benefits you'll get from your mortgage.

Adjustable-rate mortgage (ARM)

An adjustable-rate mortgage has an interest rate that changes based on changing market rates and economic trends. They usually offer an initial interest rate that is two to three percentage points lower than fixed-rate mortgages, but they don't offer the stability or assurance of a known mortgage payment in the years to come. If you don't expect to be in your home for many years, however, an ARM may be just what you need.

Balloon mortgage

A balloon mortgage offers an initial interest rate that is lower than fixed-rate mortgages. It keeps this low fixed rate for five to seven years and then requires a "balloon" payment. The balloon payment is the final payment of the loan and pays off the entire balance. Monthly payments are low because the payments for those first five to seven years are amortized at a low interest rate over the total length of the loan. If you plan on either selling your home, paying it off, or refinancing it before the balloon payment is due, then this type of mortgage is good deal.

Government loans

Government housing loans help lower the costs of mortgages so that more people can afford to own their own home. There are three government agencies that insure mortgages. The Federal Housing Administration (FHA), which is part of the U.S. Department of Housing and Urban Development, the Veterans Administration (VA), and the Rural Housing Service (RHS), which is a branch of the U.S. Department of Agriculture. Only approved lenders can offer these loans, and there will be required standards that the property has to meet in order to qualify.

Reverse mortgages

Reverse mortgages pay you money as long as you live in your home. These loans are designed for people age 62 and older who own their homes and need an inflow of cash. The loan is against the equity and isn't paid off until you sell or move out of your home. Until then, you receive regular payments in the amount set up in the terms of the loan. Reverse mortgages are offered by state and local governments as well as banks and mortgage lenders. Shop carefully for these loans because interest rates and fees tend to be higher than in traditional mortgages. The AARP Web site offers additional information about reverse mortgages.

Conventional versus Jumbo

A conventional loan is one that falls under the loan limit set by Fannie Mae or Freddie Mac. These limits change annually based on the single-family home price survey done by the Federal Housing Finance Board each October. As of 2002, a conventional loan can be up to $300,700. Loans that are above that limit are called jumbo loans. Because jumbo loans don't offer the same Fannie Mae- and Freddie Mac-backed safety to investors as conventional loans, their interest rates tend to be higher by about 0.25 percent to 0.50 percent. When the conventional loan limit changes, the FHA loan limit usually changes along with it.

Text from How Stuff Works .com