There are several different types of mortgages, and understanding the terminology can help you pick the right loan for your situation (and avoid going down the wrong path).
Again, if you want to be a stickler, we’re talking about different types of loans — not different types of mortgages (because the mortgage is simply the part that says they can foreclose if you stop making payments).
Fixed-rate mortgages are the simplest type of loan. You’ll make the exact same payment for the entire term of the loan (unless you pay more than is required, which helps you get rid of debt faster). Fixed rate mortgages typically last for 30 or 15 years, although other terms are not unheard of. The math on these loans is pretty simple: Given a loan amount, an interest rate, and a number of years to repay the loan, your lender calculates a fixed monthly payment.
Fixed-rate loans are so simple that you can calculate mortgage payments and the payoff process by yourself (spreadsheets and online templates make it easier). These calculations are a valuable exercise to help you compare lenders and decide which loan to use.
Adjustable rate mortgage loan are similar to standard loans, but the interest rate can change at some point in the future. When that happens, your monthly payment also changes — for better or worse (if interest rates go up, your payment will increase, but if rates fall, you might see lower required monthly payments).
Rates typically change after several years, and there are some limits as to how much the rate can move. These loans can be risky because you don’t know what your monthly payment will be in 10 years.
Second mortgages, also known as home equity loans, aren’t for buying a house — they’re for borrowing against a property you already own.
To do so, one will add another mortgage loan. The second mortgage lender is typically “in second position,” meaning they only get paid if there’s money left over after the first mortgage holder gets paid. Second mortgages are sometimes used to pay for home improvements and higher education. In the financial crisis, these loans were notoriously used to “cash out” your home equity.
Reverse mortgages provide income to homeowners who have significant equity in their homes. Retirees sometimes use a reverse mortgage to supplement income or to get lump sums of cash out of homes that they paid off long ago but these loans are not always as good as they sound.
Interest only loans allow you to pay only the interest costs on your loan each month. As a result, you’ll have a smaller monthly payment (because you’re not repaying any of your loan balance). The drawback is that you’re not paying down debt and building equity in your home, and you’ll have to repay that debt someday. These loans can make sense in certain short-term situations, but they’re not the best option for most homeowners hoping to build wealth.
Refinance loans allow you to swap out one mortgage for another if you find a better deal. When you refinance a mortgage, you get a new mortgage that pays off the old loan. This process can be expensive because of closing costs, but it can pay off over the long term if you get the numbers to line up correctly. The loans don’t need to be the same type. For example, you can get a fixed-rate loan to pay off an adjustable rate mortgage.
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