Buying a home is a major decision - so when it comes to choosing a mortgage, it makes sense to be informed of the options. This Be Good at Money video tutorial on mortgage types details three main questions to ask when shopping for a mortgage. They relate to repayment style, interest rate arrangements and the level of protection.
Decision 1: How shall I repay it?
The video tutorial Can I afford to buy a property? helps in determining early financial considerations of whether to buy a home. Next, the questions of the type of mortgage and loan repayments need to be answered.
A monthly mortgage payment usually consists of two parts: an amount that pays back the actual loan (the principal) and an amount that pays the interest on the amount borrowed. One option is to choose a so-called "repayment mortgage", which combines the interest repayment and loan repayment in a single transaction. Each month a small amount of the loan is repaid so that by the end of the loan agreement, the loan has been repaid in full.
Another option - called an "endowment mortgage" in some parts of the world - is to pay the interest on the loan each month and set up a separate investment plan dedicated to paying off the loan some time in the future. This second option carries more risk as it is possible the investment plan may not grow enough to repay the mortgage completely by the time the loan needs to be repaid.
Beware of interest-only mortgages
Some lenders offer "interest only" mortgages under which interest payments are made during the term and the principal is typically paid back at the end. But it can be risky for those who don't have the financial resources to pay off the principal when it falls due. Betting that you can pay off the loan by selling your home at a profit is not wise. As ING Group chief economist Mark Cliffe tells in his second video lesson from the financial crisis, real estate values can go down - and assuming they will rise might be a big mistake.
Decision 2: To fix, or not to fix?
The second major question relates to how fixed or how flexible the interest rate should be. A fixed interest rate - whereby the interest rate stays the same during an agreed period of time - might suit those who prize security. One advantage is that monthly charges are known well in advance. A variable interest rate - whereby the interest rate can move during the agreed term - might suit those with a higher appetite for risk. The mortgage holder tends to pay less if interest rates go down but more if interest rates go up. Interest rates hit extreme lows in the wake of the global financial crisis, perhaps making it tempting to choose a variable rate. However, it's generally expected that rates will rise as the global economy recovers.
Decision 3: Building protection into your loan
The third major question, says this Be Good at Money video tutorial, relates to protection. If a mortgagee's income declines or a financial emergency arises, mortgage payments might become too difficult to maintain.
As such, it pays to consider if incorporating some insurance protection into a mortgage suits.