This article will help you learn some of the basic types of Mortgages now being offered and help you understand the advantages of each one - so you can pick the best one for you.

It used to be that when you purchased a home you only had one type of mortgage to choose from - a 30 Year Fixed. In the past several years there has been an explosion in the number of types of Mortgages available - it is very confusing. After reading this article you will have the basic knowledge to understand the fundamental building blocks of the many loan types out there.

Fixed rate mortgage

In this type of a mortgage the interest rate you pay on the loan does not change throughout the period of the loan. The monthly payment is fixed throughout the life of the loan. You are paying both interest and principal each month.

Ideal Candidates: Everyone! There is a reason why this loan product was around for so long - it works. It forces you to purchase a house that you can afford now. It is conservative, tried and true.

Benefits: The benefits of a fixed rate mortgage, is that you don’t have to worry about any increase in payments throughout the loan period. Therefore, you know how much to set aside each month towards loan repayment. You are protected from any increase in interest rates.

The disadvantages are that you will generally have to pay a higher interest rate than you would with an adjustable rate mortgage. You have to be prepared to pay larger monthly payments than, you would have to with other loan products. Suppose the interest rate dipped, you may need to consider refinance.

TIP: Consider a 15 year mortgage term instead of 30 year mortgage term.

Adjustable rate mortgage ( ARM )

With this mortgage the interest you pay changes with the market (usually measured by an index such as 1 Year LIBOR or 10 year Treasury yield). Most ARMs cap the amount of increase in any given year, some don’t - so make sure you understand the impact to your monthly payments if interest rates rise to that maximum amount - otherwise you may be forced to sell.

Ideal Candidates: First time home buyers who anticipate moving in 3 to 5 years. An adjustable rate mortgage is ideal for people who want to immediately grab the opportunity of buying up a good home and are prepared to pay towards a fluctuating interest rate as they expect their income to increase in the near future.

The main advantages are:

• You gain by paying a lower interest than with a fixed rate loan as you are taking on this risk instead of the lender.

• You can buy a larger home than you could other wise afford.

• If after a couple of years, the interest rate declines, you save money on interest payments.

• This means you don’t have to go in for refinancing when the interest rates get lower and what this means is you can avoid on closing costs and fees associated with refinancing.

The drawback here is of the unpredictable nature on interest rates. What this means to your finances is that the amount that you set aside every month towards loan repayment can increase or decrease, with the rise and fall in interest rates. If the interest rates drastically double from the former rate you were paying you have to be able to handle it and make regular payments.

TIP: Most first time home buyers move out of there first home in 3 to 5 years. If this is your situation then consider an ARM that is fixed for 3 or 5 years. In a situation where you are paying less every month towards interest than what you would have paid in a fixed rate mortgage, you can save on that money and earn off this saving in a higher yielding investment.

Graduated payment mortgage loan

This loan starts with low monthly payments and then increases the payments over time. In the beginning this loan may negatively amortize, which means that the amount you owe will increase as the payments are not even covering the interest expense.

Ideal Candidates: This type of a loan is most suitable for young people who can’t afford to pay a high amount every month towards loan repayment, but expect their earnings to rise in the future. Recent Graduates and Short term investors are best suited for this loan type.

The main advantages are:

• This loan type benefits you by allowing you to make small payments every month in the initial phase of the loan repayment period.

• You can benefit by this loan type because you can use the initial phase to save on money and build yourself up for better earning prospects so that you can pay off the bigger contribution expected later.

• You can make a property investment with very little initial payments, which means a house worth a lot can be purchased through this loan for which initially you don’t; have to send so much in repayments.

TIP: Since, repayment schedules vary from one lender to another you should compare rates before you get into a loan.

Interest-only loan

In an interest-only loan you pay up only the interest amount on the loan for the first years of the loan (usually ten). At the end of this period you need to pay both interest and principal which results in an increase in monthly payments. Interest Only loans are often combined with adjustable rate mortgages.

Ideal Candidates: First time homebuyers who plan on moving in three to five years. It is suitable for business owners who expect windfall gains in a short while, from their business. Those expecting to earn infrequent bonuses or commissions or expect to make a lot more money in the near future can take this loan confidently.

The main advantages are:

• The period during which you pay only the interest, gives you time to build yourself up, so that you are in a better position of paying the principle due at the end of the loan term.

• You are able to you acquire an asset, which appreciates in value over a period of time, but your initial repayments for it are less.

• The money you gain by paying only an interest amount can be invested in other appreciable investment forms such as stocks, savings, or a small business. This can be used to later pay off the principle loan due.

The loan type is not for people who have a fixed income, which they don’t expect to rise in the near future and who don’t have the financial strategies required to make up for a huge payment later.

TIP: What if you can’t pay the entire loan amount at the end of the loan period? You can convert the loan into an interest plus principle amount loan, else you can take a new loan in which you pay the only interest amount again and extend the repayment period for another couple of years.

Balloon payment mortgage

If you want a mortgage that allows you to make lower monthly payments, but requires a large final payment at the end of the loan, a balloon payment mortgage will be ideal thing for you. The balloon mortgage can have either a fixed rate of interest or a floating rate of interest.

The main benefit here is that the interest paid off over the loan period is actually deduced from the total loan amount, so you pay less at the end of the loan period on the principle.

People who deal in commercial real estate are the ones to most benefit by this kind of mortgage as it helps them to gain property for commercial purposes for which they can use to build up their business and make the large payment at the end of the loan term.

TIP: If you cannot pay off the balloon payment at the end of the loan period, you can refinance at lower interest rates.

Second Mortgages

Home equity loan

A home equity loan is typically taken out as a second mortgage. It can also be used if the value of your home appreciates during the time that you own it. A home equity loan can have a fixed rate or adjustable interest rate.

Ideal Candidates: Anyone who is in need of solid financing for important expenses.

The main advantages are:

• They are a good source of cash, when you need it the most.

• Though the interest rate in a home equity loan is higher than a first mortgage, it is much lower than the interest rates you would pay on credit cards and other consumer loans.

• It is tax deductible unlike other loans such as auto loans, personal loans and so on.

The disadvantage of this loan is that since it is riskier, you will be paying a higher interest rate than with your first mortgage. The other disadvantage is that since it is your house that is providing the collateral, if you do not make payments on the loan you risk foreclosure. Be very careful of taking money out of your house and paying off other purchases.

TIP: Pay off any extra money that you come by into this loan.

Home equity line of credit (HELOC)

It is a type of revolving credit that you can get on your home’s equity.

• It is used as a substitute for a Home Equity Loan to enable you to get more than 80% financing towards your home.

• It is similar to your credit card line, in that once you pay it down you can draw on it again. In fact you often get a check book with this account.

• You can pay any extra money into this account knowing that if you ever needed the cash you could draw from this account again.

You will be using the credit you get from this loan for which your house is used for collateral. This is a big price to pay for credit!

TIP: Like the Home Equity Loan - pay this account first with any extra earnings/savings.