Need a Real Estate Loan? Understand the Most Popular Types
When embarking on the journey of procuring real estate loans, you might find yourself daunted by the vast array of
mortgage loans available. While this wide selection allows for personalized choices, it can also lead to confusion.
The three most common types of real estate loans or mortgages include: Amortized Loans (AL), Adjustable Rate Mortgages
(ARM), and Hybrid Loans.
Amortized Loan (AL)
An amortized loan, also known as a level-payment fully amortizing fixed-rate loan, entails equal monthly installments
throughout the duration of the loan. These payments are a combination of principal and interest, with the balance
gradually shifting from interest to principal, even as the monthly payment remains the same. This loan type offers
predictability and safety for borrowers. However, due to its lack of flexibility, interest rates are generally
slightly higher compared to adjustable rate mortgages.
Adjustable Rate Mortgage (ARM)
The Adjustable Rate Mortgage (ARM) is a widely preferred type of real estate loan. Similar to an amortized loan,
monthly payments include both the principal and interest. However, the amount may fluctuate as the interest rate
changes throughout the term of the loan, depending on the index rate(s) to which it is tied. Popular index rates
include the prime rate, LIBOR (London Interbank Offered Rate), COFI (11th District Cost of Funds Index), and various
Treasury Bill and Certificate of Deposit rates. Most ARMs have annual and lifetime caps for added security, limiting
the maximum interest rates annually and over the life of the loan. Some ARMs offer reduced initial payments, although
this is not always the case.
Hybrid loans derive their name from their ability to switch from an amortized to an adjustable rate loan, or vice
versa, based on the borrower's preference. This feature increases safety, as borrowers can convert their ARM into a
fixed rate loan during market downturns or do the opposite in times of economic growth. However, hybrid loans often
come with either higher interest rates or specific conditions for conversion. These conditions may include: an initial
period of three years or more during which the loan cannot be converted, a specific interest rate, or an additional
fee for the conversion process.
The choice among these three types of real estate loans largely depends on your personal preferences and comfort
level. If you value stability and are willing to pay a premium for it, an amortized loan could be your best bet. If
you're looking to minimize costs and are open to some risk, consider an ARM or hybrid loan. However, remember to
verify the annual and lifetime caps to avoid potential financial hurdles during the mortgage term.