Once you’ve decided you’re ready to buy a new home, you know the first thing you need to do is seek a mortgage pre-approval. Next, you’ll want to qualify for a specific mortgage.
This will be the biggest purchase of your life, and you want to be sure you’re well informed of the options available to you when it comes to financing your new home.
There are several different types of mortgages, and depending on your financial situation, some may work better for you than others.
Traditional or Conventional Mortgage
If you apply 20% or more as your down payment, this is a traditional or conventional mortgage. It’s defined as a low loan-to-value ratio, meaning the mortgage amount is low compared to the value of the property. Lenders prefer to approve this type of mortgage as their risk is far lower.
To the opposite, a high-ratio mortgage is one where the home buyer has contributed less than 20% down payment on the purchase, meaning the lender is taking a higher risk. This type of mortgage requires the buyer to take mortgage insurance to protect the lender in the case you default on your mortgage payments. This insurance is based on a percentage of the purchase price and can run you $10,000 or more. The premiums are rolled into your mortgage payment.
In a fixed-rate mortgage, your interest rate doesn’t change for the period of your term, often between one and five years. This option is best in situations of low market interest rates, where you can lock in that rate for a longer period of time to benefit from lower payments and less interest paid. In addition, a fixed mortgage rate is recommended if you are working with a tight budget and could benefit from a static mortgage payment over time.
If interest rates are low and anticipated to increase, choosing a fixed rate will allow you to extend that lower interest rate for the period of your term and not be subjected to the increase.
This type of mortgage is a bit riskier, but in certain circumstances, the risk pays off. In this type of mortgage, the interest rates are reviewed at intervals and automatically adjusted based on the current market prime rate. This adjustment affects both interest rate and payment amount and can fluctuate higher or lower based on the changing rates.
If interest rates dip down, you will benefit from a lower payment and lower interest paid. Of course, the opposite can happen as well. Adjustments may occur quite often, as often as eight times per year, so this type of mortgage is ideal for homeowners with a bit more flexibility in their budgets.
Variable Rate Mortgage
A variable rate mortgage is similar to an adjustable-rate mortgage in that the interest rate fluctuates based on the current market trends, but the difference here is that your payment amount stays the same. This means the amount of your payment applied to the principal balance of your mortgage changes depending on if the interest rate rises or falls. This type of mortgage can benefit you if interest rates are lower, and in most cases, they are lower than in a fixed rate mortgage.
If you opt for a closed mortgage, you’re restricted from making additional payments or renegotiating the terms of your loan prior to a set date. For example, a five-year fixed closed mortgage ensures you pay all and only your regular payments until the end of that five-year term. If you choose to break your mortgage terms prior to that date, you may be penalized a percentage of the interest lost by the lender. However, some closed mortgages offer limited options to pay early. Consult your lender for details.
An open mortgage is just the opposite. This flexible mortgage type allows you to make additional installments or lump sum payments without penalty. You can also make accelerated payments, where more of the payment amount is applied to the principal balance as opposed to interest. Open mortgages have a higher interest rate than closed.
This selection is just a highlight of some of the most common mortgage types available. Consult with your lender to learn more details about all the mortgage options available to you based on your financial situation and future financial plans.