In its simplest definition, a mortgage is a loan from a bank or financial institution that helps you purchase a home.
When you get a mortgage, the lender pays for the cost of the home up front, after you pay an initial down payment. In exchange, you agree to repay the money you borrow based on terms and conditions set by the lender, like an interest rate and the length of time you have to pay off the loan.
Mortgages have three elements that can be combined in different ways: a rate type, a loan type and a loan term. Knowing how these pieces work together can help you pick the right mortgage.
Rate Types: Fixed Vs. Adjustable
One decision you’ll make as a borrower is whether you want a fixed rate or adjustable rate mortgage. The “rate” refers to how much you’ll pay in interest to your lender.
- Fixed rate mortgages have an interest rate that remains the same every month throughout the life of your loan. This is a great option if you prefer consistency and ease while budgeting since the monthly payment doesn’t change.
- Adjustable rate mortgages, also referred to as ARMs, have interest rates that can change over time. This means your monthly mortgage payments won’t be the same throughout the life of your loan, though the initial interest rate you receive with an ARM is typically lower in comparison to a fixed rate mortgage.
Mortgage rates change daily. Here are today's mortgage rates.
How Adjustable Rate Mortgages Work
ARMs are actually 30-year loans and include a fixed rate for a set period of time (typically the first five, seven or 10 years of the loan). After the fixed rate period expires, your interest rate can adjust up or down based on market conditions. Don’t worry – there are caps in place so your payment won’t spiral out of control.
You’ll notice an ARM and its rate caps usually written in this format: 5/1 (2/2/5). Let’s break down what this means:
- 5/1: The “5” is the amount of years the interest rate is fixed. The “1” means that the interest rate can change once a year after the fixed period expires.
- 2/2/5: The first “2” means that the most a rate can change is 2% the year after the fixed period expires. The second “2” means that the rate can change 2% every year thereafter. The “5” represents the maximum percentage that can be added to the initial rate for the lifetime of the loan.
Keep in mind, caps can vary depending on the loan. For example, a 7/1 ARM might have a (5/2/5) cap structure.
It’s important to ask your lender about the max you could possibly pay on an ARM so you can decide if it’s best to refinance after the fixed rate period expires, or to allow the rate to adjust based on the market.
Loan Types: Conventional, FHA And More
Along with choosing what type of rate you should get, you’ll need to determine what type of loan to get as well.
- Conventional loans are the most common. Conventional loans are backed by a private lender and typically offer better interest rates and more flexible term options than government-insured loan programs. However, they require a higher down payment and stronger credit score.
- A government-insured loan, like an FHA loan and VA loan, is backed by a government agency. These loan options have more flexible credit score requirements and may have options for buying a home with little-to-no money down. However, they also tend to come with additional restrictions and fees like mortgage insurance.
- Jumbo loans are mortgages that exceed the conventional loan limit. This means that you'll need a jumbo mortgage if your loan amount is between $484,351 and $3 million.
Loan Terms: The Length Of The Mortgage
The term is the length of the loan. Most fixed rate mortgages have 30- or 15-year terms, although you can choose any term from 8 to 30 years with a Quicken Loans YOURgage. Adjustable rate mortgages typically have a 30-year term, which include an initial fixed rate period before the rate adjusts based on the market.
Deciding on your loan term depends on your priorities:
- A shorter term will allow you to pay off the loan quicker, pay less interest and build equity faster, but you’ll have a higher monthly payment.
- A longer term will have a lower monthly payment because the total amount of the loan is spread out over a longer period of time – however, you’ll pay more in interest, and it will take longer to pay off the loan.
Getting The Right Mortgage
Selecting the right combination of rate type, loan type and loan term depends on your financial situation and your goals. Our Payment Calculator can give you an idea what your monthly payment could be, and you can speak to a Home Loans Expert if you have any questions.
You can also start an application online with Rocket Mortgage® by Quicken Loans® to see what mortgage you qualify for right away.