Mortgage Types Explained

Getting the key to your new castle requires unlocking the door to a mortgage. Fortunately, the market offers a range of home loans to suit most needs and financial situations. From conventional fixed-rate mortgages to Veterans Administration-backed loans with low down payments, banks have multiple options -- even for older homeowners, who can obtain a mortgage to help cover basic expenses in retirement.

Conventional Mortgages

Conventional fixed-rate home loans are the workhorses of the mortgage world. They’re simple to understand, because their terms don’t change during the loan’s life. That means they make budgeting for future housing payments easy. Conventional loans do have drawbacks: They come with higher initial interest rates than other loan types — 3.625 percent was the going rate on a 30-year loan in early 2013. What’s more, if interest rates fall, borrowers are locked into their orginal higher payments. Conventional mortgages work well for borrowers who want to avoid risk and who plan to own the home for at least five years.

Adjustable Rate Mortgages

Adjustable-rate mortgages fluctuate as interest rates change. Their biggest advantage is that they cost less than fixed-rate loans at first. Banks were charging an average of 2.375 percent interest on five-year, adjustable-rate mortgages as of early 2013. Borrowers take a financial hit if interest rates jump, though, because monthly payments go up. Several adjustable-rate loans were on the market as of 2013. Interest on a one-year ARM changes every year. Intermediate ARMs keep rates steady for three to five years. With convertible ARMs, borrowers can switch to a fixed rate after a period of time. Also, some ARMs are interest-only loans, which let borrowers pay interest alone, rather than both principal and interest. Interest-only ARMs have their own pitfalls: They reset after three to five years, and borrowers must refinance on the remaining loan amount and make catch-up principal payments. Adjustable-rate mortgages make sense if interest rates are high in general, you don't plan to own for long or you expect your income to increase.

Balloon Mortgages

Borrowers with balloon mortgages enjoy relatively low payments on a fixed-rate loan for a period of years. After that introductory term, which can last as long as 15 years, the mortgage’s entire balance is due. Homebuyers may be able to refinance their loan balance to satisfy repayment, but closing costs can eat up savings from those early low payments. If you’re in a career that promises significantly higher earnings in a few years or if you plan to sell before your balance is due, a balloon mortgage may be an option.

Federally Backed Mortgages

Government agencies including the U.S. Department of Veterans Affairs and the Federal Housing Authority guarantee mortgages with low down payments of as little as 1 to 3 percent. There are catches, though. You have to be a veteran to qualify for a VA loan, and you have to buy in an FHA-certified community to get an FHA mortgage. Also, as of 2013, the upper limit of your loan is $417,000. Expect to pay slightly higher interest rates than you would on a conventional loan. These loans work best for borrowers who haven’t been able to sock away cash for a big down payment.

Reverse Mortgages

For homeowners 62 and older, reverse mortgages can help cover living expenses. The loans let owners borrow against equity and continue to live in their home. Borrowers don’t need to repay the loan or any interest or fees until they or their estate sell the property. Homeowners are still on the hook for maintenance, property taxes and homeowners insurance, and they lose the option to take out a second mortgage or rent out their place. Before they get a reverse mortgage, borrowers should consult with advocacy or trade groups such as the AARP or the National Reverse Mortgage Lenders Association. They should also verify that their loan is federally insured.

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