Types of Mortgages
A very common type of mortgage loan is the fixed-rate mortgage (FRM). This is a mortgage loan whose interest rate stays the same for the duration of the loan, whether it’s a 15-, 20-, 30- or 40-year mortgage.
A fixed-rate mortgage does have its benefits. The first being relatively low risk. Since it’s a fixed-rate mortgage loan, borrowers will know what their basic mortgage payment will be, which enables them to plan for the long-term. Also, fixed-rate mortgages have built-in inflation protection. Even if interest rates increase, mortgage payments on a FRM will remain the same.
Now the same built-in inflation protection that’s seen as benefit can also be a hindrance in a falling interest rate environment. If interest rates go down, your FRM will not. The only way to take advantage of the lower interest rate is to refinance your mortgage.
Fixed-rate mortgage loans usually do not include additional costs which can increase overall monthly payments. These additional costs are generally paid through the escrow account, which is a trust account established in the borrower’s name to pay costs like property taxes and insurance premiums.
Adjustable-rate mortgages (ARMs) are loans with interest rates that change.
So you may ask yourself, why would I want a mortgage loan where my interest can change? Well, borrowers usually seek to take out an ARM because the rates are generally lower in the initial loan period, which means a lower monthly payment in the beginning. This may enable borrowers to quality for a larger home loan than if they went with a fixed-rate mortgage. But keep in mind, the interest rate can fluctuate over the course of the loan. Sometimes monthly payments can significantly increase even while national rates stay the same, or if national interests decline, the ARM monthly payments may not change much at all.
The question to ask yourself is:
How long do I plan to live in the home? If it’s longer than five years, maybe an ARM is not for you. The risk of interest rates increasing after your initial adjustment period is greater. If it’s less than five years, the risk of interest rates rising while paying an ARM loan is usually less of an issue.
If you’re 62 or older and you don’t plan on moving from your home for many, many years to come and you would like to supplement your current income, then it’s possible
a reverse mortgage is for you. Reverse mortgages supplement your income by tapping
into your home’s equity. In general, it’s a loan against your primary home that you do not
have to repay for as long as you live in that home. Income from a reverse mortgage is tax-free.
The loan can be paid to you in various ways:
- All at once.
- A monthly cash payment.
- An open line of credit.
- You can also combine a line of credit and monthly cash payments for as long as you live or a certain time period.
A reverse mortgage means your lender sends you cash based on your home’s equity which you don’t have to repay. The amount that you owe the lender increases as your cash payments increase and interest is tacked on to your loan.
In general, as the amount you owe increases, the equity in your home decreases. And essentially, this is what a person who takes out a reverse mortgage wants. While living in your home, you essentially "spend down" the equity in your home by receiving monthly cash payments, a lump sum of money or an open line of credit which you can access at will.
But please note: Reverse mortgages can be costly, with extensive closing costs and fees.
Generally, reverse mortgages come in three forms:
- Home equity conversion mortgages, or HECMs, which account for about 90 percent of all reverse mortgages. These are federally backed by the U.S. Department of Housing and Urban Development.
- Proprietary reverse mortgages.
- Single-purpose, low-cost reverse mortgages for those whose income qualifies.
Keep in mind that purchasing a reverse mortgage is not a decision to make lightly. It does have downsides, such as there will be decreased assets left for your heirs. This type of mortgage is not for everyone. So, be sure to consult with your financial planner and close family members that you trust before entering such an arrangement.
You can also visit AARP.org for further information, as well as RMAAPR.org to access the Reverse Mortgage Calculator. This will give you a general idea of what to expect as a cash payment to you.
So again, if you think this type of loan is for you do your extensive due diligence and consult a financial planner first.