Mortgage loans are named after the form of the capital and interest associated payments. The three major types of mortgages are fixed rate, adjustable rate and balloon payment. Sometimes loan institutions offer structured loans with hybrid interest rates including periods of repayment with both variable and fixed interest rates. Each type of home loan has different capital and interest paying forms which create advantages and disadvantages for the home buyer.
Fixed rate mortgages have a set interest rate for the entire period of the loan implying that the monthly instalment will not change either during the life of the loan. This fact provides protection against unexpected rises in interest rates that would increase the monthly payment. On the other hand, in the case of dropping interest rates, the buyer will always have the option to refinance the loan and benefit from the lower interest rates. Fixed rate mortgages usually have higher interest rates than the adjustable rate mortgages to account for the increased interest rate risk incurred by the bank. Given the predictability of the monthly instalments, the fixed rate mortgage are the safest type of home loan and oftentimes the more desirable.
Adjustable Rate Mortgages have a fluctuating interest rate that is correlated to the prevailing market interest rate. As a consequence the monthly payments will move in tandem with the interest rate. The adjustable rate is linked to an index, such as the FED rate, which is determined by the lender and may differ from mortgage to mortgage. The lender usually sets a number of other terms that include the interest rate adjusting period which can be anywhere from every 3 months to once a year, the level of each interest rate increase or decrease on any adjustment date, and whether there is an interest rate floor/cap on how low/high the interest rate can drop/rise. Usually, adjustable rate mortgages come with the lowest interest rates. Frequently, loan institutions market adjustable rate mortgages with very low introductory interest rates to be in effect for a short period of time. Adjustable rate mortgage is a good choice when interest rates are stable or falling.
The balloon mortgage has a set interest rate for a specific amount of time and fixed monthly payments. At the end of that time, the entire loan principal becomes payable. Practically, a balloon mortgage is part of a hybrid home loan that will be serviced initially by fixed monthly payments for several periods and followed by adjustable monthly payments.