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Types of loans

There are four basic types of mortgage loans: fixed rate loans, adjustable rate loans, convertible mortgage loans and balloon mortgage loans.

Fixed-rate loans. Because they offer a monthly payment that is known and does not change, fixed-rate mortgage loans remain the most popular type. Most fixed-rate mortgages are for loan terms of 15 or 30-years. A 30-year loan has lower payments but a slightly higher interest rate.

Adjustable-rate loans. After an initial term, the interest rate on an adjustable-rate mortgage ARM loan is re-set periodically. This is to keep the rate in line with current market interest rates. For example, a 3/1 ARM loan offers a fixed rate for the first three years, adjusting once a year thereafter. A 5/1 ARM loan offers a fixed rate for the first five years, adjusting yearly thereafter. The lender sets the interest rate by adding a margin to an index rate. Most ARM loans have a periodic rate cap and lifetime cap to limit the amount the interest rate can increase each adjustment period and over the term of the loan, respectively. If you have a payment cap in your loan agreement, you may face negative amortization of your loan. This has the effect of increasing the amount you owe.

Convertible loans. An adjustable-rate home mortgage where the borrower has the option to change the loan terms into a fixed-rate loan at any time.

Balloon mortgage loans. These loans often have interest-only payments. In this case, you don't amortized any loan principal and the entire loan amount is due at the end of the loan term. A balloon mortgage allows you to minimize your monthly payments until you refinance the loan. Another advantage is that a larger share of your payment may be eligible for the mortgage interest tax deduction.

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