Home Loan Guide

Step 2

Understanding Your Loan Choices

Once you have established what you require from a loan, you need to become familiar with the different types of loan choices available in the market. The followings are the most common loan programs available:

A. Fixed Rate Mortgage

The fixed rate mortgage is the most common loan program. The interest rate is locked for the entire term of the loan no matter how the market interest rate varies. Therefore, your monthly payments will remain the same until you pay off your loan. You have the security of knowing exactly how much your monthly principal and interest payment will be. However, fixed rate loans usually have higher rates than the starting rates of adjustable loans and are more difficult to qualify. If the market rate decreases, borrowers have to pay a certain amount to refinance their home in order to benefit from the decreasing rate.

Term: 15-year or 30-year
When considering a fixed rate mortgage, you can choose from two popular terms: 15-year and 30-year. 15-year fixed rate mortgages are very popular programs because they allow borrowers to pay off the loan quickly, save interest expenses and build equity rapidly. However, monthly payments are higher than 30-year fixed and are therefore more difficult to qualify.

Fixed rate mortgage will be your best choice if:

You need to be exact in your monthly budget.
You expect to live in your home for more than ten years.
You predict your income to be stable.

B. Adjustable Rate Mortgage

The adjustable rate mortgage, commonly known as an ARM, is a loan type that allows the interest rate and the monthly payment to change at a specified adjustment period over the term of a loan. The interest rate is determined by a financial index plus a margin. Most ARMs offer low initial rates for the first six to twelve months, then the index-tied rate will be adjusted regularly according to the terms.

In order to protect borrowers from ever-rising rates, most ARMs limit the rate changes by interest rate caps such as life time caps and periodic caps. Life time caps limit the maximum interest rate for the life of the loan and periodic caps limit how much the interest rate may change at each adjustment. Some ARMs may even have payment caps to limit the amount that borrowers need to pay. However, payment caps may lead to negative amortization which means that your principal loan amount is increasing instead of decreasing.

An ARM can be your best option if:

You are looking for a more affordable initial monthly payment. ARMs typically offer a lower initial interest rate, therefore lower initial monthly payment and less up front and closing costs.
You predict interest rates will be stable or even decrease.
Your monthly budget will allow you to be comfortable even if your monthly payment increases.
You may have difficulty in qualifying for a fixed rate loan.
You do not plan to stay in the house for very long.

C. Convertible Mortgage

The convertible mortgage is a loan type with a monthly payment that is fixed for a number of years, and then it will be adjusted regularly over the term of the loan. Interest rate varies within the life time and periodic caps, and up-front costs will be lower as compared to the fixed rate program. The interest rate that is fixed for the initial few years is usually lower than that of a fixed rate mortgage. A convertible loan may give you the affordability of an ARM and the stability of a fixed rate program.

A convertible mortgage will be your best option if:

You do not want to pay loan fees as high as those of the fixed rate loan, and you are looking for a stable interest rate for the first few years.
You plan to stay in your house for less than 10 years. You may change to a bigger house, or re-finance for your home loan within 10 years.

D. FHA Mortgage

The FHA mortgage is a loan which is guaranteed by the Federal Housing Administration for repayment of loans. It makes home ownership possible for many borrowers who otherwise might not be able to afford it. FHA loans allow a lower down payment and longer repayment period as compared to conventional loans. Even part of your closing cost can be financed by an FHA loan. However, there is a maximum loan amount limit which differs by county and borrowers have to meet FHA standards in order to be qualified for a FHA loan.

A FHA loan will be your best option if:

You have low cash reserves for down payment.
You are in the low- to moderate-income level and would have difficulty in qualifying for a conventional loan.

The market is full of different loan types to choose from. Remember to identify your needs and use them as criteria for the type of loan to look for. When shopping for a loan, you should become familiar with the loan types, terms and fees charged by lenders. Be sure to compare the A.P.R. (Annual Percentage Rate) for similar types of loans. For the definition of A.P.R., please refer to "Understanding the Terminology" section.