How you pay back your mortgage is arguably the most important aspect of the home-buying process. When you're loan shopping, you'll come across a number of different kinds of loans and payment options. Before you pick one, you should know how some of the most common options work and consider which one best suits your needs.
Payments anyone can do
For most mortgages, you'll be able to make payments on your loan in three common ways.
This is the
most common type of payment. You make a monthly payment covering both the principal and interest due. By the end of the loan's term, your loan and interest will be paid in full.
This monthly payment can either stay the same, as with fixed-rate mortgages, or fluctuate, as with adjustable-rate mortgages.
One way to chip away at your principal balance faster is to make
biweekly payments. With this method, you pay once every two weeks, which comes to 26 payments a year. This payment schedule can shave a few years off a 30-year FRM and save you thousands of dollars in interest.
If you want to pay more toward your
principal, it's your right to do so, and it's a good idea for those who want to stay put. Sending your lender a check with "for principal only" written on it is one way to do this.
Some repayment options are offered only with certain loans. The following loans are the most common:
FRM payments are made once a month and are fully amortized. The interest rate is fixed and the monthly payment amount never changes. The typical length of an FRM is 30 years, but it can be as short as five years and as long as 50.
ARM payments can change each month or each year, depending on the loan's terms. Some ARM loans have a fixed-rate payment period for several years before changing to an
ARM with fluctuating payments. ARMs usually come with a cap on how much your interest rate or monthly payment can rise.
The fluctuating payments of ARMs can be difficult for some home buyers to keep up with. However, ARM interest rates are usually lower than FRM rates. They can be advantageous if you move often or don't plan to see out the life of the mortgage.
Option or payment-option ARMs give you a choice of how you want to pay on any given month. They include:
- Interest-only payments
- Fully amortized payments (you pay both the principal and interest due that month)
- A limited payment, which might not cover the interest or principal amount
This flexibility can be beneficial or troublesome for borrowers. You should know how each payment change affects the overall amount you owe on your loan.
Interest-only loans offer an initial payment period in which you pay back only the interest. Also, most interest-only loans are adjustable-rate, so your monthly payment can change.
When the interest-only payment is up, you usually have three options to pay off the principal:
- Pay it in full
- Make monthly payments on the principal
This payment plan is considered risky. The amount due each month decreases with each interest payment, but when the interest-only period ends, the monthly payments on the principal are larger. This can stress your financial situation if you aren't ready.
Some loans, called balloon mortgages, require you to pay off the remaining loan in full after a period (typically five to seven years) of low monthly payments. This type of loan can get you into a lot of trouble if you don't have a
rock-solid financial plan, or can't refinance, and want to stay in your home.
Balloon mortgages often come with lower interest rates and low down payment requirements. This payment plan may be useful for those who don't want to stay in the home long term and instead plan to sell.
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