Fixed, Adjustable, Graduated, and Balloon Mortgage Loans: Which is best when you buy a house?

In this second article in our series of mortgage loan types, we will discuss the types of loan terms and payments you can choose when buying a house. Which is best? That all depends on your circumstances. Read up to help determine what works best for you.

Fixed Rate Mortgages– A fixed-rate mortgage (FRM) loan is just what it sounds like – your monthly payment and the interest rate you pay when you buy a house are fixed and do not change throughout the life of the loan.  In the beginning of the loan term, your payment goes largely toward paying interest. As your equity increases, more of your payment is used toward the principal. Fixed-rate mortgages can run from 10 to 40 years. With a fixed-rate mortgage, the shorter the length of the loan, the lower the interest rate, and the higher the monthly payment. FRMs are best if you are most comfortable knowing you have a set amount to budget for each month.

Adjustable Rate Mortgages – Adjustable or variable mortgage loans are on the other end of the scale. An ARM’s interest rate changes in line with any one of several indexes, including Constant Maturity Treasury (CMT), Treasury Bill (T-Bill), 12-month Treasury Average (MTA or MAT), Certificate of Deposit Index (CODI), 11th District Cost of Funds Index (COFI), Cost of Savings Index (COSI), London Inter Bank Offering Rates (LIBOR)Certificates of Deposit (CD) Indexes, Bank Prime Loan (Prime Rate)Fannie Mae’s Required Net Yield (RNY), and National Average Contract Mortgage Rate. Along with the interest rate, your monthly payments will change as well. To protect you from extreme monthly increases, most mortgage loans have an interest rate cap built in that will limit the fluctuation. ARMs can be a good choice if the market is in your favor.

Graduated Payment Mortgages – Graduated payment mortgage (GPM) payments start low and gradually increase. The schedule for the increase is set at the time the loan is granted. Many GPM payment plans adjust the rate of the increases with the life of the loan. GPMs with larger overall increases or longer periods initially start with lower payments. The advantage of a GPM is that you can qualify for a larger loan than you might otherwise.

Balloon Loans – A balloon loan is a short-term fixed-rate loan with a set monthly payment until the end of the loan. At the end of the loan term, there is a lump sum payment or balloon. Balloon loans are usually three, five, or seven years in length. These loans typically have a lower interest rate. Sometimes, they will have a refinancing option at the end.