While trying to find the lowest rates, many homeowners fail to examine the type of mortgage, and which type of mortgage is best suited to their needs. Whether you are buying a new home or refinancing, it is important to understand the different mortgage types, and evaluate which one best meets your needs.

The most important decision is that between fixes rate mortgages and adjustable rate mortgages (or ARMs).

Fixed rate mortgages have interest rates set at the time of purchase, and these interest rates remain fixed. By getting a fixed rate mortgage, the borrower can “lock in” the rate. This is a low risk strategy for those who are comfortable with the existing interest rate. However, if interest rates fall, fixed rate mortgages will still have to pay the higher interest rates.

Adjustable rate mortgages are generally cheaper than fixed rate mortgages in order to entice borrowers. But these lower rates are not guaranteed, and the rates will go up corresponding to an increase in interest rates. But the rates can also go down, and these mortgages are becoming far more popular with the consistently low interest rates of recent years.

The decision between fixes rate mortgages vs. adjustable rate mortgages will come down to financial expectations, and the ability to tolerate risk. Those who are confident their earning power will increase might be more comfortable with an adjustable rate mortgage that has lower payments now, but risks higher payments in the future. On the other hand, those who are satisfied with existing interest rates, and feel that the rates are likely to rise will want to lock in these rates for the long term.

In either case, mortgages can be refinanced, but refinancing a loan costs money, and the best savings will be available to those who don’t need to refinance often.

Another type of loan that has become popular in recent years is the interest only loan. In fact, an interest only loan is not a type of mortgage; it is just an option that can be applied to a mortgage. With an interest only loan, the borrower is free to pay only the interest, but not make any payments towards the principal. This lowers payments, although the loan is not actually getting paid off. This type of loan may be attractive to those who believe leverage in their home’s value is more important than actual ownership since their house value will increase. It is a speculative position.

Balloon loans are similar in many ways to the interest only option on mortgages. The balloon loan allows the borrower to pay off the principal at a later date, and pay interest only up front at set rates. In the ultimate derivation of a balloon, or interest only loan, a homeowner owes the entire sum of the original loan amount after 30 years of paying interest.

Two step loans are another option, where a fixed rate is settled for a number of years, and then a new fixed rate is set up after 5 or 7 years with a one year adjustable for the remainder of the loan.

Choosing the right type of mortgage for your financial situation is an important decision that could save many thousands of dollars over the long run. There is no one correct answer for all people in all financial situations, but it is important to understand the types of loans, and how the match with your personal financial expectations.

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