The Common Sense Investor

There are almost as many types of mortgages as there are people trying to get a mortgage. Here, we break mortgages down into five standard types.

As with most forms of loan instruments, mortgages offer a variety of types with different features. Each of these types of mortgage provide alternative ways of getting a loan in order to finance your purchase of a house. With the wide range of mortgage types that are being offered, you are likely to find one that will be perfect for your needs.

If you have the cash, its often best to pay for your house up front. Your second best option is to get a low fixed-rate mortgage for either 15 or 30 years. This way you are guaranteed a low rate: good for both financial and psychological reasons. If you can’t get a good fixed rate, then the next best option is typically a 5 or 7 year ARM that moves from a fixed rate to a variable rate. These are especially good if you only plan to stay in your house for 7 or fewer years. ARMs can provide a slightly lower rate for the first 5-7 years when you always pay the most interest.

Below we review a handful of the many different types of mortgage available to you:

Fixed Rate Mortgages

In this type of mortgage, the monthly interest rate remains constant for a set time period ““ the period of time can be 30, 15, 10, 7, 5, 3 or even 1 years. Often times, in the case of 30 or 15 year fixed rate mortgages, you will have paid off the loan by end of the period. However when this fixed period ends, if you have not paid off your mortgage, the rate usually changes into a variable rate (these are typically called ARMs - adjustable rate mortages and are usually available in 7, 5, 3 and 1 year periods). A fixed rate mortgage guarantees that the interest rate will remain the same every month for the duration of the fixed rate period even if mortgage rates rise. The disadvantage to these loans is that if interest rates fall, you will still be stuck with the high interest rate unless you refinance (and incur refinancing fees).

Variable Rate Mortgage

The variable rate could either refer to the lender’s standard variable rate (SVR) or the rates that track an external rate or even the tracker rates. The advantage of a variable rate mortgage is that the amount you pay rises or falls depending on certain market factors. This means that if the indicators are lower then you get to enjoy lower interest rates. The disadvantage is that if the market indicators rise then the interest rates imposed on you also rise, thus you end up paying more. The rates on variable rate mortgages are usually lower than the current fixed rate. However, if you think the variable rate will move up significantly, you may be wiser to go with a fixed rate mortgage instead.

Capped Rate Mortgage

Just like a variable rate mortgage, your payments in a capped rate mortgage may go up or down. But the difference is that the amount the rate increases is restricted by cap or upper limit for a set time period. There is also another mortgage type similar to this called a Cap and Collar Mortgage where the rate does not only have a cap but also has a collar ““ a limit to the amount you pay if the rate drops. This mortgage gives you a certain stability in that the rate will not go higher than the stated cap. This means that you are protected from too high an increase which can help you stay within your budget. Although it may not be as good as a fixed rate mortgage because a capped rate can often be higher than the fixed rate.

Discounted Rate Mortgage

This means that your payments are based on a discounted interest rate set below the variable rate for a set time period. The time period is usually very short afterwhich the amount you pay could rise sharply. A discounted rate allows you to make lower payments in the early part of the loan. The disadvantage is that you could get hard on the back end when the discounted rate expires.

Cashback Mortgage

In this type of mortgage, instead of getting a discount, you get a lump sum or cashback based on the value of your loan. The advantage here is that you get actual cold cash which you can use for other things (moving, renovations, furnishing, etc) that you are planning for your new home. The disadvantage though is that the cashback could make the rate quite a bit higher than other types of mortgages.