If you’re planning on buying a home, you need to be aware of the different types of mortgages available to you and the advantages and disadvantages to each.

There are two main types of mortgages that most every home loan program will offer: fixed-rate mortgages and adjustable-rate mortgages.

Fixed-Rate Mortgage

A fixed-rate mortgage has the same interest rate for the life of the loan (hence “fixed”), the borrower makes monthly payments, and a portion of each payment covers the interest rate.

Below are some of the different kinds of fixed-rate mortgages and the pros and cons of each.

Conventional Fixed-Rate Loan

These mortgages are long-term loans that typically come in 15-year or 30-year payoff agreements.

Pros:

  • Predictable and stable payments
  • The interest rate doesn’t suffer when market rates rise

Cons:

  • The initial interest rate is higher than an ARM
  • The interest rate doesn’t benefit when market rates fall

Fixed-Rate Balloon

This is a short-term loan that requires regularly monthly payments then after a certain period of time, the remainder of the loan is due in full. The loan then must be paid off in cash– a balloon payment –or be refinanced.

Pros:

  • Predictable and stable payments
  • The interest rate doesn’t suffer when market rates rise
  • Lower interest rate than conventional fixed-rate

Cons

  • The interest rate doesn’t benefit when market rates fall
  • The initial interest rate may be higher than an ARM
  • You might have to refinance to pay off the balloon
  • The interest rates could be high by payoff time

Interest-Only Loan

An interest-only loan allows you to pay only interest on the loan for a set period of time, then can either renew the loan or repay the principal at the end of that time.

Pros:

  • Predictable and stable payments
  • The interest rate doesn’t suffer when market rates rise
  • Lower monthly payments

Cons:

  • The interest rate doesn’t benefit when market rates fall
  • The initial rate may be higher than an ARM
  • You have to renew, repay early, or refinance
  • You can’t refinance through amortization

Biweekly Loan

This loan requires payments every two weeks rather than once a month.

Pros:

  • Predictable and stable payments
  • The interest rate doesn’t suffer when market rates rise
  • Lower monthly payments
  • You could pay off the loan quicker by squeezing in extra payments per year on a biweekly basis

Cons:

  • The interest rate doesn’t benefit when market rates rise
  • The initial rate may be higher than an ARM
  • More payments each year

Adjustable Rate Mortgage

An adjustable-rate mortgage, or variable-rate mortgage, fluctuates with the market. Periodically, the interest rate and payments are adjusted to reflect the market.

Standard ARM

This type of mortgage is as described above.

Pros:

  • Lower initial interest rate compared to fixed-rate
  • The payments drop when the market rates fall

Cons:

  • Payments are not stable and change over time
  • The payments will increase when the market rates rise

Convertible ARM

This is a type of adjustable-rate mortgage that allows the borrower to convert their mortgage to a fixed-rate mortgage within a specific window of time.

Pros:

  • Lower initial interest rate compared to fixed-rate
  • The payments drop when the market rates fall
  • You can “lock in” lower rates if they drop

Cons:

  • Payments are not stable and vary with the market
  • Higher initial interest rate than standard ARM
  • The payments increase as the market rates rise
  • Have to pay fee to “lock in” lower rates

Two-step Mortgage

This is an ARM that adjusts your mortgage only one time. There’s typically one interest rate for the first five, seven, or 10 years of a loan and then a different interest rate for the remaining life of the loan.

Pros:

  • The initial interest rate is fixed for a period of time
  • Lower initial interest rate compared to fixed-rate
  • The payments drop when the market rates fall

Cons:

  • Payments fluctuate based on the market at one specific point in time
  • The payments increase as the market rates rise
  • There’s some risk involved since the future interest rate is unknown

Balloon ARM

This mortgage is a combination of a balloon loan and an adjustable-rate mortgage. Payments vary from period to period like an ARM and the final payment is due as a lump sum like a balloon loan.

Pros:

  • Lower initial interest rate compared to fixed-rate
  • The payments drop when the market rates fall

Cons:

  • Payments are not stable and vary with the market
  • The payments increase as the market rates rise
  • May have to refinance to pay off the balloon
  • Interest rates could increase at payoff

Interest-Only ARM

This mortgage requires only monthly interest payments like the fixed-rate interest-only loan, but like an ARM it often has a period when it switches from a fixed rate to adjusted rates over time.

Pros:

  • Lower monthly payments
  • The payments drop when the market rates fall

Cons:

  • Payments are not stable and vary with the market
  • The payments increase as the market rates rise
  • It does not reduce the loan principal

Graduated-Payment Loan

A graduated-payment mortgage has a very low initial interest rate then increases over the first three to five years. After the initial period of increase, the interest rate stays constant over the remaining term of the loan.

Pros:

  • Low initial monthly payments

Cons:

  • Payments increase over time
  • Lenders can change your premium
  • Negative amortization in early years

Conclusion

Whether a fixed-rate mortgage or an adjustable-rate mortgage is right for you, be sure to examine both options closely to find what works with your finances before putting money down on a home.