One of the most important differences between types of mortgages are their interest rates. Mortgages have either a fixed interest rate, which remains unchanged for the life of the loan, or an adjustable rate. Adjustable-rate mortgages, also known as ARMs, usually require the borrower to pay off the loan over the same 30-year period as with a fixed rate mortgage, but after a certain period of time (usually one year) the lender can increase interest rates annually, resulting in a higher monthly payment for the homeowner.
Hybrid mortgages combine elements of a fixed-rate mortgage with those of an ARM. Instead of allowing the lender to increase interest rates each year, a hybrid mortgage requires the lender to wait for a number of years before changing the interest rate for the first time. Thereafter, the lender may change the interest rate only as often as the mortgage agreement stipulates.
Some borrowers may be able to take advantages of mortgages that offer special assistance to make home ownership possible for more people. To make it easier to get a mortgage, even with an imperfect credit rating or without the savings to make a large down payment, the Federal Housing Administration backs mortgages through commercial lenders. These loans pose less of a risk for lenders since the federal government will step in to subsidize any losses because of default or bankruptcy. Homeowners whose mortgages become unaffordable may be able to secure an interest-only mortgage, which allows them to pay only the interest that the loan earns each month, and put off paying down the principal until they are more financially stable.
The mortgage loan that a home buyer uses to purchase the home is not necessarily the last loan in the borrowing process. As homeowners pay off the principal on the first mortgage, they create equity in the home. Homeowners can borrow against home equity by taking out a second mortgage. The two major types of second mortgages are home equity loans, which provide the homeowner with an upfront lump sum payment, and home equity lines of credit, which allow the homeowner to make charges to an open account as needed. In both cases, homeowners continue to pay off the first mortgage and add a new monthly payment for the second mortgage. Second mortgages can fund anything from home improvements to a child's education or unexpected medical bills.
Refinancing is a way for homeowners to replace an existing mortgage with one that has more favorable terms or provides money for paying other expenses. Homeowners may wish to refinance for a variety of reasons, including to take advantage of new, lower interest rates that occur when the economy slows down and federal interest rates fall. A cash-out refinancing plan is similar to a home equity loan, but instead of creating a new loan it replaces the existing mortgage and pays the homeowner cash based on home equity, which becomes part of the new mortgage's principal amount.