A loan isn't just a loan when it comes to mortgages. Here are some different types:
Fixed Rate: A specified fraction of the loan will be owed to the bank over the course of the loan. The amount does not change and the monthly payment will be the same over 15 or 30 years. This type of interest rate is very popular.
ARM: This is an adjustable-rate mortgage. The interest rate changes to mirror changes in the credit market.
The initial rate of an ARM is generally lower than the rate available on a fixed-rate mortgage; but remember, the rate may change during the lifetime of the loan. Don't hesitate to ask the lender how one loan differs from another, how the different features of the loan will affect the mortgage, or whether your chances to qualify would improve if you made a higher down payment.
The first-year rate (aka the teaser rate) is usually a couple of percentage points below the market rate. There is also a cap, which is the highest limit for the interest rate. For example if your first-year rate is 5 percent, and you have a five-point cap, then the highest that your interest rate can go is 10 percent. In addition, interest rates are limited to an increase of one or two points a year. Thus, it is important to know how often the rates will change.
A type of ARM is a Cost of Funds Index loan. There are no caps with this loan and it adjusts monthly. It is the most flexible of any of the ARM mortgages because it does not have a fixed rate for a particular period of time. One advantage of the COFI loan is that there is no set payment each month.
Another type of ARM mortgage is a hybrid loan. It is set for 1, 3, 5, 7 or 10 years and then switches to an ARM. This gives you steadiness for some time, and then some existing interest rates.
These loans provide the low rates of an ARM and the stability of a fixed loan.
They usually are shown in a 5/25 or 7/23 form. You will see that the two numbers add up to 30 in both cases. This ratio means that in the first five or seven years your interest rate will be fixed, and in the next 25 or 23 years the loan will either become an ARM or a fixed rate loan. The advantage to this is that the initial interest rate is usually lower than a standard 30-year fixed loan.
These are short-term loans that are treated as if they are 30-year loans. The term usually last from three to seven years and the outstanding funds are paid in one mass sum. This loan has lower interest rates and, if you will be moving and selling at the same time your balloon mortgage is due, it might be a good option for you.
On the other hand, if you do plan on staying in your house longer than originally planned, then you will have to pay off the loan completely and also get another loan, which can get expensive.