Mortgages, equity lines of credit, second mortgages – these terms are often tossed around by lenders, but do you know what they really mean? It may seem like Homebuying 101, but knowing the difference between these types of loans is a crucial part of making your first home purchase or improving the one you live in right now.
Types of Mortgage Loans
A mortgage is a loan secured by some sort of real estate – it can be your primary residence or a home you purchase for an investment. Once you get the loan from your lender, you pay it off in installments over a set period of time, usually 15, 20 or 30 years. While lenders write all kinds of loans, including reverse mortgages and those that have “balloon” payments, they can be divided into two basic types:
- Fixed Rate. A fixed rate mortgage gets the interest rate at the time the loan is written, so you pay the same amount of money every month for the life of the loan. These types of loans are the most common mortgages written today, and they have the safety of knowing that the payment amounts won’t change. On the other hand, because the interest rate is fixed, even if rates drop, the payments will stay the same unless you refinance the mortgage. Rates for a fixed-rate loan may also run higher than other types of mortgages.
- Adjustable Rate. Also called an ARM, this type of loan starts with a lower interest rate and lower payments for an introductory period of time, but then “adjusts” periodically, usually causing an increase in payments. Adjustable rate loans often have a “cap,” which limits how much the rate can increase during the life of the loan. These mortgages seem best for those who only plan to own the property for a short period of time.
Types of Equity Loans
Equity loans (also called second mortgages) are loans secured by the equity, or the amount the property is worth over and above the money owed on the mortgage. If your home is worth $200,000 and you owe $150,000 on your mortgage, you have $50,000 in equity.
You can get an equity loan as a lump-sum amount of money, and then make payments on the principal and interest of the whole amount, or you can get an equity line of credit. A line of credit is an approved amount of money that you can access by writing a check or using a credit card as you need it, so you only pay for that portion of the loan that you actually use. The payments for equity loans are based on the amount owed and the current interest rate, so they can fluctuate as the rates go up and down.