Different types of mortgages
With a Fixed-Rate Mortgage, your monthly payment of principal and interest never change for the life of your loan. Your property taxes may go up (we almost said down, too!), and so might your homeowner's insurance premium part of your monthly payment, but generally with a fixed-rate loan your payment will be very stable.
Fixed-rate loans are available in all sorts of shapes and sizes: 30-year, 20-year, 15-year, even 10-year. Some fixed-rate mortgages are called "biweekly" mortgages and shorten the life of your loan. You pay every two weeks, a total of 26 payments a year--which adds up to an "extra" monthly payment every year.
During the early amortization period of a fixed-rate loan, a large percentage of your monthly payment goes toward interest, and a much smaller part toward principal. That gradually reverses itself as the loan ages.
You might choose a fixed-rate loan if you want to lock in a low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can give you more monthly payment stability.
Adjustable Rate Mortgages -- ARMs, as we called them above -- come in even more varieties. Generally, ARMs determine what you must pay based on an outside index, perhaps the 6-month Certificate of Deposit (CD) rate, the one-year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others. They may adjust as often as every month or as little as once a year.
Most programs have a "cap" that protects you from your monthly payment going up too much at once. There may be a cap on how much your interest rate can go up in one period--say, no more than two percent per year, even if the underlying index goes up by more than two percent. You may have a "payment cap," that instead of capping the interest rate directly caps the amount your monthly payment can go up in one period. In addition, almost all ARM programs have a "lifetime cap." With a lifetime cap, your interest rate can never exceed that cap amount, no matter what.
ARMs often have their lowest, most attractive rates at the beginning of the loan, and can guarantee that rate for anywhere from a month to ten years. You may hear people talking about or read about what are called "3/1 ARMs" or "5/1 ARMs" or the like. That means that the introductory rate is set for three or five years, and then adjusts according to an index every year thereafter for the life of the loan. Loans like this are often best for people who anticipate moving--and therefore selling the house to be mortgaged--within three or five years, depending on how long the lower rate will be in effect.
You might choose an ARM to take advantage of a lower introductory rate and count on either moving, refinancing again, or simply absorbing the higher rate after the introductory rate goes up. With ARMs, you do risk your rate going up, but you also take advantage when rates go down by pocketing more money each month that would otherwise have gone toward your mortgage payment.
Another increasingly popular mortgage option is an Interest Only Mortgage. This mortgage product works best for those who have income that comes from commissions or bonuses. With an interst-only mortgage, you will only pay the interest due on your mortgage for a fixed amount of time (typically 5 or 10 years). After this 'interest-only' period, your monthly payment will increase to a predetermined amount that will allow you to pay off your mortgage by the end of the term.
Balloon Mortgages are similar to an ARM in that you will receive a lower interest rate, but after a predetermined number of years (usually 3, 5, or 7 years) your mortgage ends. At that time, you have to either pay off the remainder of the loan balance (with a "balloon" payment) or refinance the mortgage. Payments are typically amortized over 30 years at an interest rate that's usually lower than a fixed rate mortgage. This mortgage product might be a good choice for you if you plan on moving before the loan's maturity date. However, if you plan on staying in the home, this mortgage may not be the best product for you.
If you are self-employed or have not established in your commission-paid job for more than two years, a No-Doc Mortgage is a good option. When reviewing a no-doc mortgage, a lender's underwriter will typically only look for a good credit report. If your credit scores are high enough and you do not have any (or very little) recent derogatory credit on your report, you can get easy mortgage approval without having to provide a lengthy financial history and documentation. The cost to you is a slightly higher interest rate, but remember, you are literally providing no documentation to the lender; they are approving you based solely on your good credit report.