Choosing The Right Mortgage Product

Several different types of mortgages are offered on the marketplace.

Amortizing vs. Interest Only (Non-Amortizing): An increasingly popular option, especially among first-time buyers, is to choose non-amortizing, interest only mortgages. According to the terms of these mortgages, the borrower pays only the interest on the principal each month no more (and therefore does not pay pay down the mortgage principal). BestCashCow.com believes that many buyers are using these mortgages to stretch their financial means too thin. Since the outstanding mortgage principal is never reduced, the borrower's ability to build equity in their home is limited to the appreciation in value of their home before they sell it. Interest only mortgages are a very risky proposition if you believe as many do that there is a real estate bubble since a decline in the value of the home could leave the homeowner with negative equity in their home.

Fully Amortizing vs. Balloon: A fully amortizing mortgage involves payments of principal that are geared or scheduled so that the entire principal balance will be paid off at the end of the mortgage. A mortgage that is not fully amortizing may involve a part of the monthly payment each month attributable to paying down principal (or may not - see Interest Only Mortgages above), but not completely pay off the mortgage by the end of the mortgage term. Instead, they leave the borrower with a balloon, or one time payment, that they need to make in order to extinguish the outstanding liability associated wit the mortgage at the end of the mortgage term. Borrowers cannot be certain of the availability of new lending sources and rates and the end of the term; and they also want to avoid additional closing costs. Therefore, BestCashCow.com advises homeowners to purchase fully amortizing mortgages unless they anticipate having the means to pay off the balloon and the end of the mortgage term or do not plan to live in the home until the end of the term.

Terms: Mortgages terms may vary. Fully amortizing short-term mortgages are appropriate for borrowers that have the ability to make larger payments, thus accelerating the amortization and building equity more quickly. Long-term mortgages are more suitable for borrowers wanting the security of budgeting for the future who plan to live in their homes for long periods.

Adjustable Rate Mortgages (ARMs) vs. Fixed Rate: A borrower can choose a fixed or variable interest rate. A fixed rate mortgage allows the borrower certainty on the payment amount for the full term of the mortgage—amortizing mortgages are usually from 15 to 40 years. The initial fixed rate period under an ARM is followed by adjustment intervals. For example, a "3/1 ARM" is fixed at an initial low rate for the first 3 years, and then adjusts every year based on an index (Fed Funds Rate, CPI, LIBOR, etc). Common ARMs are: 1/1, 3/1, 5/1, 7/1, and 10/1. ARMs are often offered at substantially lower rates than fixed rate mortgages for their initial fixed period. Unlike fixed rate mortgages, these mortgages can climb sharply immediately thereafter. These mortgages are ideal for borrowers who do not intent to live in their homes for a period exceeding the fixed period or for borrowers who intend to have the ability to pay off the mortgage at the end of the fixed period. Borrowers intending to live in their homes for longer periods and who will not have the means to pay off the an ARM should the rate rise dramatically are usually better served to lock into fixed rate mortgages.

Closed vs. Open Mortgages: So-called closed mortgages may offer very slightly lower interest rates than open mortgages of the same term, but they have terms limiting the borrowers ability to pre-pay or pay down the mortgage balance. Open mortgages allow the borrower the flexibility to pay off as much as you want, any time, without penalty. Many states have legislation forbidding closed mortgages. BestCashCow.com recommends that they be avoided even where available.

Conventional vs. high-ratio mortgages: A conventional mortgage equals no more than 75% of the appraised value or purchase price of the property, whichever is less. A high-ratio mortgage is usually for more than 75% of the appraised value or purchase price. High ratio mortgages are often referred to as an NHA mortgage because it is granted under the provisions of the National Housing Act and must, by law, be insured through CMHC for which the borrower pays the insurance premium as well as application, legal and property appraisal fees. Purchasers of condomium or cooperative apartments are often required by board management to purchase conventional mortgages (i.e., to own at least 25% equity in their homes at purchase).

Assumable vs. Non-Assumable Mortgages: Assumable mortgages are relatively rare. A homeowner with an assumable loan can "hand off" the loan to a buyer instead of paying it off using proceeds from the home sale. If rates are low and you can get one, by all means do so. If rates rise, buyers will want to assume your loan (and might be willing to pay more for your house) because it will be much cheaper than any loan they could get from a bank or other source.

Portable vs. Non-Portable Mortgages: Traditionally in the U.S., a mortgage must be repaid upon sale of the mortgaged property (i.e., it is not portable). In Canada, the UK and elsewhere, some mortgages are portable and may be taken transferred by a borrower from a home that is sold to a home that is purchased. In the U.S., E*TRADE briefly introduced and then removed the portable mortgage from the marketplace. Portable mortgages place the risk of interest rate hikes squarely on the lending bank. Therefore, portable mortgages would be a very interesting product for those likely to move often who are seeking to lock in historically low interest rates over long periods of time, allowing them to transfer the balance when they move.

Once you've understood the options available, check out rates on different mortgage products.

If you need help understanding mortgage products or terms, please visit BestCashCow.com's section on Financial Terminology.