So, you’ve decided that now is the time to move forward with your dream of homeownership. While you might be daydreaming about what the future in your new home holds, it’s important to remember that there is a lot of information you’ll have to consider. It’s great to be excited, but let’s be practical too! One of the first decisions you will have to make is the type of mortgage that you’ll choose. In this article we will discuss the most common mortgage types:
- Conventional mortgages
- High ratio mortgages
- Assumable mortgages
- Variable rate mortgages
- Fixed rate mortgages
Each mortgage type comes with a principal and an attached interest rate that must be repaid on a monthly basis until the term of the mortgage is over. This is where the similarities end, as each different type of mortgage functions in different ways.
With this type of mortgage, you must be able to make a down payment of at least 20% of the home’s total value. A conventional mortgage cannot be taken out otherwise, because these mortgages will only facilitate up to 80% of the home’s value. A conventional mortgage boasts a lower interest rate than high-ratio mortgages, which makes it easier to pay off the mortgage’s principal.
With a down payment as low as 5%, a high-ratio mortgage affords prospective homeowners the chance to get a mortgage when a conventional mortgage is out of reach. However, there are some drawbacks to obtaining a high-ratio mortgage. First, you will be made to purchase mortgage insurance. This additional cost will be added to your mortgage payments and protects the lender in the event of default. Second, this type of mortgage also comes with significantly higher interest rates.
Let’s say that a homeowner is two years into a five-year mortgage term. Now, let’s say that they want to sell the home. The person who purchases the home from them would be entering into an assumable mortgage. This is typically preferred when mortgage rates are rather high, as the home buyer gets to get in on the mortgage’s existing interest rate. If the mortgage was initially obtained with a 7% interest rate and the current market dictates a 10% interest rate, the person entering into an assumable mortgage gets the 7% rate rather than the current rate.
Variable Rate Mortgages
The three mortgage types above can either be fixed-rate mortgages or variable-rate mortgages. A variable rate mortgage can be a risk, but it may also offer great savings with lower interest rates. The market fluctuates often, which impacts the interest rates attached to mortgage loans. A mortgage of this type reflects these changes. When the market dictates higher rates, the homeowner pays a higher interest rate. But when interest rates dip, homeowners get the benefit of paying less in interest.
Fixed Rate Mortgages
Unlike variable rate mortgages, a fixed-rate mortgage does not change in response to the market. Instead, homeowners pay a consistent interest rate with their monthly payments. This does not carry the risk that variable rate mortgage agreements do, but it doesn’t allow homeowners to take advantage of lower interest rates, either. The rate that you and your lender agree upon initially will be what you pay in interest throughout the term of your mortgage.
It helps to understand the different mortgage types, so this guide is a great place to start. Make sure to make your decisions carefully as you move forward on the path to homeownership. The wrong choice could cost you thousands, but a wise decision could save you even more.