There are several residential mortgage loan options to choose from. Deciding which loan is the best involves an evaluation of your personal finance situation, how long you expect to be in the home, and the level of risk you are comfortable with. Some of the more popular types include the fixed rate, the adjustable rate (ARM), and the interest only mortgage.
A fixed rate mortgage loan is considered by many to be a good choice if you plan on staying in the home longer than five to seven years. This type of residential mortgage loan consists of a fixed interest rate for the life of the loan, which is generally 10, 15, 20 or 30 years in duration. The amount of principal and interest that borrowers pay remains the same for duration of the loan and is easy to budget for. For the first few years, the majority of the payments go towards interest.
The main advantages of a fixed residential mortgage loan are stability and lower monthly mortgage payments if the current borrowing rates are low. A disadvantage is that in a high interest rate environment, the monthly payments will be higher and some borrowers might not qualify based on their income. While fixed rate mortgages are the most common, they may end up costing home buyers more if they do not plan to stay in their homes longer than five to seven years.
An adjustable rate mortgage (ARM) involves a combination of fixed interest rate periods and floating rate periods. This type of residential mortgage loan is best suited for borrowers who don't anticipate staying in their homes for a long time. The ARM has a fixed interest rate for a set amount of time that may range from three to ten years. After the fixed interest rate period, the rate adjusts according to market indexes, margins and adjustment caps.
In a higher priced housing market, the ARM is a convenient way to get approved for a mortgage amount that you otherwise might not. Initially, the mortgage payments will be lower and more affordable than that of a fixed rate loan. If you only plan on staying in the home for the fixed rate period of the ARM and then sell the property, you reap the benefits of paying less. An adjustable rate mortgage may be eligible for refinancing at the end of the fixed rate period, which allows you to potentially avoid any interest rate fluctuations.
Disadvantages of the ARM residential mortgage loan include a higher risk factor and an eventual higher payment amount in a low interest market. The legal language of adjustable rate mortgages is notorious for being complicated and confusing. For those borrowers who see themselves staying in their properties longer than seven years, the ARM carries much uncertainty and the risk of unaffordable monthly payments.
Interest only loan borrowers do not pay any of their principal balance at the beginning. The monthly payment amount is lower for the interest only period, but then increases substantially. This allows some borrowers the ability to initially purchase a home they otherwise could not afford. Risk and uncertainty is high with this type of mortgage loan, however. Borrowers may find that after the interest only period expires, neither the home's value nor their income has increased enough to sell the home or make up the difference in monthly payments.