Additional Types of Mortgages
Within the broader mortgage categories of fixed and adjustable-rate, there are plenty of other variations, such as COFI, Hybrid, and Balloon loans, several of which combine aspects of the two main types. Let's take a look.
One type of ARM is a COFI loan. COFI stands for "cost of funds index." This loan doesn't have any caps, and adjusts monthly. It is, in a sense, the most adjustable ARM of all, since it isn't fixed for a certain time. But, the index to which it is tied is, in many ways, the most stable index of them all: It is tied to the rate that banks have to pay their depositors to keep their money (i.e., checking accounts, savings accounts, certificates of deposit). It tends to be a slow-moving index. The COFI loan has certain advantages in that you can vary the amount of your payments as you wish (paying off more or less each month). If this suits your temperament and your budget, inquire about it since it is often not brought up as an option.
Just as in a candy store, why have two flavors when we can have a mix and make three? Sure, your hands might get sticky and your tongue can turn green, but we like freedom of choice. Typically a hybrid loan is fixed for 1, 3, 5, 7, or 10 years and then converts to an ARM. This means you get stability for a given amount of time, and then your fate is cast to the winds of the prevailing interest rates. If you imagine a fixed-rate mortgage as a motorboat, and an ARM as a sailboat, then you get to run the ship under its own engines for a time before you unfurl those sails and hope for favorable winds.
These loans attempt to provide the best of both worlds: the stability of a fixed loan with the lower rates of an ARM.
They appear in their most common forms as 5/25 or 7/23 loans. Math buffs among you will note that the numbers straddling those slashes add up to 30, as in a 30-year loan. This means that your interest rate will be fixed for the first five or seven years, then the loan adjusts in one of two ways: It will either become an ARM, adjusting annually, or a fixed-rate loan. The beginning interest rate for these loans is generally lower than that of a standard 30-year fixed loan.
These tend to be short-term loans. You borrow money for, say, three or seven years, and the loan is amortized as though it were a 30-year loan. At the end of the three- or seven-year period, you owe the bank all of the remaining principal, in one lump sum -- like a big balloon. Again, these loans tend to have lower interest rates than the standard 30-year mortgage. If you're not planning to stay too long in your house, you might be interested in such a loan. The reasoning goes like this: You pay less in interest over the course of the loan than you would with a 30-year fixed loan -- saving potentially thousands of dollars. So, you're less out-of-pocket when it comes time to sell.
Keep in mind, though, that if for some reason your plans change and you want to stay in the house, you're going to have to pay off the loan in full -- by getting another loan, at the prevailing interest rates and with the attendant costs of getting that new loan. So, it isn't for the faint of heart or irresolute of mind.
Regardless of what type of mortgage you're interested in, you also need to figure out where you'll get it from: a bank or a mortgage broker.