Different types of mortgages
January 16th, 2007A mortgage can be widely classified 2 ways - the fixed rate mortgage (FRM) and the variable rate mortgage (VRM).
The FRM is the simplest form of mortgaging that does not change its interest rate during the pay-off period. That means you will be able to predict the cost of the house for the entire period of the loan. Most often an FRM is offered as a fixed payment mortgage for the lifetime, though a few FRMs are available with rising payment options. The later type of mortgage is called graduated payment mortgage (GPM).
Another version of the FRM is the interest-only mortgage. In this mortgage, there is a term called the interest-only period where you will pay only the interest due for the entire loan amount, unless you make voluntary payments in between. In effect, you will be paying a less EMI in the initial periods, and after the interest-only period, the payment will zoom up, making you feel that you still owe the entire loan even after a considerable number of payments. The better option to avoid this alarming situation is to fund the mortgage with alternate investments such as an endowment policy, a pension fund, or another property.
Variable type mortgage, as the term suggests, does not offer a ‘fixed interest rate.’ The rate fluctuates according to the market conditions. While some people calculate this as great risk, most of others accept it considering the boom in the industry and the competition among the banks to offer lesser rates in the future. In countries such as UK, Australia, India and South Africa, the banks are given the authority to increase or decrease the interest rates according to the market situations. This often results in an unexpected burden on the borrower. In the USA, on the other hand, the banks are offering a fixed interest rate for an initial period of up to ten years. The fixed interest period is often seven years or ten years. The advantage of this to the homebuyers is that they are entitled for a comparatively lower interest rate in the initial period than that in the fixed rate mortgage plan. But the disadvantage is that at the end of the fixed-rate period, the interest is likely to rise by more than 6%. However, realty experts advise borrowers, who are likely to stay in their home for a period of 7 to 10 years, this as the best option as they avail the FRM benefits for a lesser interest rate.
Lender Buydown is another popular mortgage offered for enthusiastic homebuyers. In this the initial interest rate is discounted and later it is increased. For example, if the current interest rate is 10 percent, the buyer may get a discounted rate up to 8.5% in the first year, and slightly increased, say 1%, in the next year, and about 10.5% or a rate equivalent to that of the FRM, for the remaining period of the loan. The advantage of this type is that the buyer pays off lesser EMIs in the initial stages, and also that they avail the benefits of a fixed rate plan from the third year onwards.
With more mortgage options being added, your task of selecting the right option will be surely difficult. A bit of advice from a mortgage advisor will help you to avoid the risks of choosing the wrong plan.
