Mortgage Guide

Other Types of Mortgages

The mortgage market is much more diverse than some borrowers think. Besides the standard fixed-rate and adjustable-rate mortgages, there are other types of mortgages and ways to finance a home.

Some of the other types of mortgages include:

  • Jumbo mortgages
  • Assumable mortgages
  • Construction mortgages
  • Seller financing
  • Two-step mortgages
  • Balloon mortgages

Jumbo mortgage

This is considered a nonconforming loan because it exceeds the loan limit set by Fannie Mae and Freddie Mac, the two publicly chartered corporations that buy mortgage loans from lenders, thereby ensuring that mortgage money is available at all times in all locations around the country. The single-family limit changes annually and the current limit is always posted on Bankrate. If you need to borrow more than that, you will need a jumbo mortgage, which generally has a higher interest rate than "conforming" loans. Lendgo.com also surveys jumbo mortgage rates.

  • Pro: Opportunity to buy larger, more expensive home.
  • Con: Pay a higher interest rate in exchange for the lender's higher risk.

Two-step mortgages o Hybrid ARMs

These are mortgages that combine elements of fixed and adjustable-rate mortgages. They go by confusing names such as 2/28, 5/25 or 7/23. A two-step mortgage features a fixed rate and payment for an initial period, followed by one adjustment, then a fixed rate and payment for the remainder of the loan term. A 7/23, for example, has an initial fixed period of seven years, an adjustment, and then 23 more years of payments following the adjustment.

  • Pro: Opportunity for damaged-credit borrowers to buy homes and to establish better credit.
  • Con: If your credit does not improve, you could be stuck in a high-rate loan for much longer than two or three years.

Balloon mortgage

Borrowers get lower rates and payments for a specific period of time, which usually is anywhere from three years to 10 years. At that point, a borrower has to pay off the principal balance in a lump sum. Under certain conditions, the mortgages can be converted to fixed-rate or adjustable-rate loans. Many borrowers either sell their homes before they get to their due dates or end up refinancing their balances into new mortgages.

  • Pro: Save on mortgage costs initially -- a great option if you don't plan on living in the home long.
  • Con: Plans sometimes change. If yours do, you will have to pay off or refinance the balance, which takes time, effort and more closing costs.

Assumable mortgage

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'll be much cheaper than any loan they could get from a bank or other source.

  • Pro: Reduces monthly payments and saves money on closing costs.
  • Con: Sellers charge more for houses, so buyers need more cash to cover the difference between asking price and loan balance.

Construction mortgages

Construction loans help people who want to build homes, rather than buy existing ones. They typically feature a two-step borrowing process. Borrowers pay higher rates for the duration of construction, during which time they draw money to pay their builders, paying only interest on the outstanding amount. Then, they go through a second closing at which time the loan usually converts to a traditional, long-term fixed-rate structure.

Seller financing

Seller financing is an agreement in which the seller of the home provides financing to the buyer. The buyer makes monthly payments to the seller instead of the bank. The promissory note is secured by the property. This type of financing often includes an assumable mortgage.