One of the best ways to finance a home purchase is through a home loan. Today, you will find many types of loans being offered by banks or financial institutions. Getting into a home loan is more than just borrowing finance, it is about understanding how the regular monthly installments can affect your finances in the short terms as well as in the long term.

In the following section, we will be discussing how interest rates and the length of loan period can affect you financially, so that you have a better perspective on the kind of loan you want to borrow to finance your home buying.

Fixed rate mortgage:

Let’s take the classic fixed rate mortgage as it is fairly easy to understand. Here you will have to spend a fixed amount every month for the entire loan period.

Suppose you have borrowed $300,000 on a 6.5% interest rate, every month your payments will be $1,896. This amount is used to pay two components: The Principal amount and the Interest Amount. Principal is the amount of loan balance due and Interest is the expense amount. Over time the Interest expense decreases as you pay off the Principal.

Adjustable rate mortgage:

On the other hand in an adjustable rate mortgage, your interest rate for an initial period can be low, but can rise later. Looking to some figures here for the same amount of $300,000 with an interest rate of 3.5%

Principal amount - $271

Interest amount- $875

Total amount - $1,146

Many people get attracted to this form of a loan type because it offer a much lesser monthly installment than a fixed rate mortgage. However, if suddenly the interest rates were to rise, the amount of monthly interest you have to pay every month can rise dramatically, much more than in a fixed ate mortgage.

For example, after five years of paying at a rate of 6.5 %, if the interest rate suddenly rose to 8.5% your monthly payments could be:

Principal amount - $271

Interest amount - $2125

Total amount $ - $2396

This is even higher than a fixed rate mortgage. However, if you expect your income to rise considerably over the coming years, you can pay off the raised interest income without any problems. On the other hand, if your income prospects don’t look too great or your feel you can’t handle the pressure of higher interest rates in the future, it would be better to opt for a fixed rate mortgage.

Interest only loans

In this loan type, since you pay only the interest amount for the interest only interval period usually the first 10 years. After this period the loan converts to a fully amortizing loan, that is one in which both interest and principal needs to be paid back.

So, for a loan of $300,000, the interest amount will be $1,625 for loan interval period. After this period is over (after ten years) you will have 20 years to pay back the loan. This will result in a new monthly payment of $2,237 – assuming the same interest rate. Of course you have the option of re-financing into a new loan and hopefully your income has increased in the future.

Negative amortization loan

In this form of loan, you pay lesser than what you actually owe for the interest every month. The short fall every month is added to the next month’s interest payments. This is an expensive loan type and you can see your principal loan amount increasing by the amount of unpaid interest added to it.

For example, for a loan of $30000, on a 6.5 interest percentage, the payments for the first month will be:

Month 1

Interest amount - $1,625,

Actual payment - $500

Shortfall – $1125

Now this shortfall will be added to the $30000, principal loan amount so next month the 6.5 interest rate will be base don $301,125. So you payments for month 2 will be:

Interest amount - $,631,

Actual payment - $500

Shortfall – $1131

At the end of the loan period you pay back the principal amount, which is a considerable one, because so many years of accumulated interest have to be paid off to the bank. It is attractive yet dangerous given the fact that you owe more to the lender due to the added on interest.

Summary

Understanding the different features of each mortgage type and looking into realistic figures of your current and future expenses toward loan repayments will help you decide which loan is best suited for your financial situation. You should avoid taking on a mortgage type that overburdens you financially both now and into the near future.