Mortgage types: Fixed vs. variable, 30-year and other loan terms, and more

When buying a home, you’ll face a host of choices. You may be debating a smaller home or condo in the city versus a larger one in the suburbs. You might be weighing school districts, looking at proximity to relatives, or factoring in your commuting time. But you’ll also have to decide how to pay for your home.

Fixed vs. adjustable-rate mortgages

This is one of the major choices you’ll have when choosing a mortgage. An adjustable rate mortgage, or ARM, comes with an interest rate that will change periodically based on an interest rate index. A fixed-rate mortgage, on the other hand, keeps the same interest rate throughout the entire term of the loan.

People who choose an ARM typically do so because it comes with an attractive introductory interest rate. How long that rate lasts will be spelled out in your loan documents, and sometimes in the shorthand description of the loan. For example, a 5/1 ARM will keep its original rate for five years, and then readjust every year after that.

The risk is that you could end up with much higher monthly payments on your loan than you expected. However, many ARMs have limits on how much they can raise their rates, called initial adjustment caps and interest caps. These terms are worth reviewing if you’re considering an ARM.

The majority of home buyers—80% to 90%—choose fixed-rate mortgages. With a fixed-rate mortgage, you know what your monthly payments will be for the life of the loan.

If you plan to be in your home for a shorter term—say, five years or less—but you still prefer to own rather than rent, an ARM might be your best bet.

Other types of mortgages

Although the vast majority of your mortgage questions may revolve around the rate and the term, there are other, more exotic mortgage options out there. Depending on your personal situation, one or more of them might be worth a look:

• Balloon mortgage. This loan is structured with lower monthly payments until the very end of the mortgage term, when you’ll be required to pay off the balance in one giant payment—at least twice the monthly payment, and usually many times that amount. At that point, you’ll be faced with a big decision and a big risk: You can pay off the balance, take out a new loan at the prevailing rate, or sell the home. With a balloon mortgage, you’ll have to ask yourself whether those lower payments are worth the risk.
• Jumbo mortgage. This is for mortgage balances above the “conforming mortgage” limits set by Fannie Mae, Freddie Mac, and their regulator, the Federal Housing Finance Agency (FHFA). For 2022, the conforming ceiling is $647,200 in most places, and $970,800 in areas deemed “high cost.” Jumbo mortgages used to come with much higher rates than conforming loans, but that’s no longer the case. In fact, because many jumbo mortgage borrowers have high credit scores, the rate difference is often negligible.
• Piggyback mortgage. This is when you take out two loans: a mortgage and a home equity loan or home equity line of credit. The mortgage is to pay for the home, and the second loan is to help you make a 20% down payment on that home. By having that 20% down payment, you can avoid the cost of mortgage insurance.
• Interest-only mortgage. This type of mortgage—as the name implies—requires you to pay only the interest portion of a conventional mortgage, which means you’re not paying down the principal balance. Interest-only mortgages came under fire in the wake of the 2008–09 financial crisis for exacerbating the severity of the housing market meltdown. They’re not nearly as popular nowadays. Fannie Mae and Freddie Mac are no longer allowed to purchase these loans, which means the lender must keep the loan on their books.