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Types of Mortgages

The majority of buyers cannot afford to buy their home as an
outright cash purchase. They have to seek financing, and that
typically means going to a bank or mortgage broker to apply
for a mortgage. There are a dizzying array of options
available for mortgage financing, but below we'll discuss the
most common types.


Fortunately for buyers, there are a variety of mortgages to choose from. It is in your best interest to investigate each of them to determine which is the best for your situation. You probably won’t qualify for all of them. In fact, you may only qualify for one. But if you do qualify for more than one, you may save yourself money (and worry) in the long run if you do your homework before signing on the dotted line.

  • Fixed-Rate Mortgages
  • Adjustable-Rate Mortgages
  • The Convertible ARM

Fixed Rate Mortgages

Consider a fixed rate mortgage if either of the following describes you:

  • You plan on living in your new home for many years, and/or
  • You are not a risk-taker and prefer the stability of knowing how much your payment will be each month. Since most home loans are for a period of 25 years, if you want a payment you can count on for that long of a period of time, a fixed rate mortgage may be what works best for you. Keep in mind however that 10 years in the maximum fixed rate mortgage term here in Canada. Making extra payments to principal will allow you to pay your loan off sooner.
  • This may not always be the best choice, however. If interest rates are very high at the time you take out your loan, with a fixed rate mortgage you’ll be stuck with that high interest rate. Conversely, if interest rates are very low, you’ll come out the winner with interest rates that will stay low no matter how high interest rates go in the future.

Adjustable-Rate Mortgages (ARMs)

If you are more comfortable in taking a risk with your money or if interest rates are very high at the time you take out your loan, an adjustable-rate mortgage (ARM) may be the solution for you. You might also choose this type of loan if your planned ownership of the property is short-term or if you expect your income to increase to cover any potential rise in the interest rate.

Generally, the interest rate when you take out your loan will be lower than a fixed-rate mortgage. Please note that this is true initially, not necessarily long-term.

Since an ARM rate rises and falls depending on the prevailing interest rate, your mortgage payment will rise and fall accordingly. If your income is not sufficient to cover the highest possible payments, then this option is not for you. On the positive side, the lower initial payments will allow you to qualify for a larger loan than if you choose a fixed-rate. The downside is that your payments will increase if/when the rates go up.

Typically, ARM interest rates are tied to a the Federal prime lending rate and your payment will be based on the rate your lender uses plus a margin, generally of two to three points. Get the formula used by your lender in writing and make sure you understand what it means.

Fortunately, most of the time, but not always, the amount an ARM can increase is limited. Typically there are “caps” on how much your lender can increase your rate, both for a period of one year and for the life of the loan. Plan ahead, and find out if this is the case with your lender. If there is a cap have your lender calculate what the maximum payment would be if your rate went to the highest amount allowed by the cap for your particular mortgage. If you are not confident you’ll be able to pay that amount on a monthly basis, perhaps you should reconsider this type of loan.

Convertible ARMs

 

If neither the fixed-rate or the adjustable-rate mortgage seems like the best option, perhaps the convertible ARM will be right for you. This alternative combines the initial advantage of an ARM with a fixed rate after a predetermined number of years. Obviously, this type of mortgage has more advantages when the initial interest rate is low and the future rate is not guaranteed.