Types of Loans

A 2/1 buy down mortgage is one where the interest rate increases 1% at the end of the first year and another 1% at the end of the second. It then remains at a fixed interest rate for the remainder of the loan term. The rate reductions could be paid by the borrower or the seller as a purchase incentive.

This type of mortgage allows the borrower to qualify at below market rates so they can borrow more. Borrowers often refinance at the end of the second year to obtain the best long-term rates. However, keeping the loan in place even for three full years or more will keep their average interest rate in-line with the original market conditions.

This loan is fully amortized over a 15-year period and features constant monthly payments. It offers all the advantages of the 30-year loan, plus a lower interest rate—and you’ll own your home twice as fast. The disadvantage is that, with a 15-year loan, you commit to a higher monthly payment.

Many borrowers opt for a 30-year fixed-rate loan and voluntarily make larger payments that will pay off their loan in 15 years. This approach is often safer than committing to a higher monthly payment, since the difference in interest rates isn’t that great.

The traditional 30-year fixed-rate mortgage has a constant interest rate and monthly payments that never change. This may be a good choice if you plan to stay in your home for seven years or longer. If you plan to move within seven years, then adjustable-rate loans are usually cheaper. As a rule of thumb, it may be harder to qualify for fixed-rate loans than for adjustable rate loans.

When interest rates are low, fixed-rate loans are generally not that much more expensive than adjustable-rate mortgages and may be a better deal in the long run, because you can lock in the rate for the life of your loan.

An ARM is a mortgage whose rate is adjusted periodically to reflect current market trends. When it comes to ARMs there’s a basic rule to remember…the longer you ask the lender to charge you a specific rate, the more expensive the loan.

This loan has an interest rate that is recalculated once a year.

With this loan, the interest rate is recalculated every month. Compared to other options, the rate is usually lower on this ARM because the lender is only committing to a rate for a month at a time, so his vulnerability is significantly reduced.

These increasingly popular ARMS—also called 3/1, 5/1 or 7/1—can offer the best of both worlds: lower interest rates (like ARMs) and a fixed payment for a longer period of time than most adjustable rate loans. For example, a 5/1 loan has a fixed monthly payment and interest for the first five years and then turns into a traditional annual adjustable-rate loan, based on then-current rates for the remaining 25 years.

The first number represents the number of years in a fixed-rate mortgage. The second number represents the number of years in the adjustment interval. It’s a good choice for people who expect to move (or refinance) before or shortly after the adjustment occurs.