Published November 14, 2011
The mortgage world can be a confusing place. Every mortgage has variables that determine how much a borrower ends up paying, and technical jargon can make it tough to understand what you're getting into.
Most shoppers simply want a good deal on a loan. Making apples-to-apples comparisons can be difficult, but a little education can go a long way toward landing the right mortgage at a great price.
Bankrate offers many tools to help you find the best mortgage. You can search for top mortgage rates or use an online mortgage calculator to weigh options and compare costs. But before you begin, take a look at the different types of loans available today and who is most likely to benefit from using them.
30-Year Fixed-Rate Mortgage
What is it? This mortgage combines a stable fixed interest rate with a long loan term that helps create manageable payments for millions of American families. During the years leading up to the current mortgage crisis, many homebuyers strayed from this time-tested formula in search of exotic loans with lower interest costs. Today, many borrowers are returning to the 30-year fixed-rate fold.
Who is it good for? Borrowers who plan to remain in their homes for a long period of time and/or want the security of knowing their monthly payment will never change.
15-Year Fixed-Rate Mortgage
What is it? This mortgage typically offers lower interest rates than its 30-year fixed-rate counterpart because banks don't have to price in as much long-term inflation risk. Borrowers who purchase a 15-year fixed-rate mortgage must pay off the loan more quickly. But they also build equity faster than homeowners with 30-year mortgages.
Who is it good for? Buyers of less expensive homes who hope to avoid a big chunk of interest costs by paying back the mortgage faster. This loan also appeals to homeowners seeking to refinance their mortgages without extending the term back out to 30 years.
30-Year Jumbo Mortgage
What is it? Jumbo mortgage loans are 30-year fixed-rate loans too big to be bought and repackaged by mortgage giants Freddie Mac and Fannie Mae for resale to investors. Banks that issue jumbo mortgages have to hold onto the debt themselves, thus incurring more risk (which is compounded further by the large amount of money at stake).
As a result, jumbo borrowers can expect not only a higher interest rate on their loans, but also more difficulty finding lenders.
Who is it good for? Buyers of large, expensive or midrange homes in areas of the country where housing is more costly.
What is it? ARM stands for adjustable-rate mortgage. Unlike fixed-rate mortgages, these loans don't have a rate guaranteed to remain stable for the length of the term. The introductory rate on these loans, which lasts only for the first year, often are significantly lower than rates on fixed-rate loans. The term for these loans is typically 30 years.
One year into the loan's term, the interest rate on this ARM (and the resulting payments) adjusts periodically based on a mortgage index such as Libor or COFI. In a falling-rate environment, that's a good thing, as it results in lower payments. However, if rates increase, you'll be stuck with higher payments.
Who is it good for? Buyers who do not plan to stay in their homes very long and who are looking for lower borrowing costs. Also, borrowers with enough cushion in their income to cover higher payments should rates increase.
What is it? The 5/1 ARM is an adjustable-rate mortgage that has a fixed rate for five years. After that time period, the rate adjusts periodically. The term for these loans is typically 30 years. Like the 1-year ARM, borrowing costs are tied to a mortgage index such as Libor, or London Interbank Offered Rate, and COFI, or 11th District Cost of Funds. Buyers benefit from lower borrowing costs when interest rates fall, but feel the pain of higher payments when rates rise.
Who is it good for? Buyers who intend to sell within five years and are looking to cut down on their mortgage costs. Also, borrowers with enough cushion in their income to cover higher payments should rates increase.
Find the latest mortgage index rates.
What is it? Mortgage indexes such as Libor (London Interbank Offered Rate) and COFI (11th District Cost of Funds) represent the constantly fluctuating rates lenders pay to borrow money as economic conditions change. Adjustable-rate mortgages are tied to these indexes -- mortgage contracts usually set an adjustable rate at Libor or COFI, plus a certain number of percentage points called a margin.
Borrowers with ARMs -- especially those whose loans are approaching their reset date -- should keep an eye on these indexes to help plan for fluctuations in mortgage payments.
Other Types of Mortgages
What is it? Over the years, mortgage lenders have devised a variety of home loan products designed to appeal to homebuyers. The interest-only mortgage allows a buyer to purchase a home and pay only the interest, leaving the principal untouched for a fixed period of time.
Balloon mortgages offer lower rates over a period of time before the loan balance comes due. Assumable mortgages can be transferred from a homeowner to a buyer, alleviating the need for a new mortgage to clinch a sale.
Private Mortgage Insurance
What is it? Private mortgage insurance, or PMI, protects a lender against suffering a loss in the event a buyer defaults on a loan. PMI covers any shortfall between the price the home fetches when resold by the lender and the amount the homeowner owes.
Lenders typically require PMI for loans with an outstanding balance that is 80 percent or more of the home's current market value. Keep in mind that although borrowers pay PMI, the insurance does nothing to protect them; it's strictly for the lender's protection.
Once homeowners reach 20 percent equity, they have the right (under the Homeowner's Protection Act of 1998) to request cancellation of PMI.