While the different choices may seem overwhelming at first, the overall goal is really quite simple: you want to find a loan that fits both your current financial situation and your future plans. Though this article discusses some of the more common loan types, you should spend time talking with different lenders before deciding on the right loan for your situation.

General categories of loans
Most loans fall into three major categories: fixed-rate, adjustable-rate, and hybrid loans that combine features of both.

• Fixed-rate mortgages
  As the name implies, a fixed-rate mortgage carries the same interest rate for the life of the loan. Traditionally, fixed-rate mortgages have been the most popular choice among homeowners, because the fixed monthly payment is easy to plan and budget for, and can help protect against inflation. Fixed-rate mortgages are most common in 30-year and 15-year terms, but recently more lenders have begun offering 20-year and 40-year loans.

• Adjustable-rate mortgages (ARM)
  Adjustable-rate mortgages differ from fixed-rate mortgages in that the interest rate and monthly payment can change over the life of the loan. This is because the interest rate for an ARM is tied to an index (such as Treasury Securities) that may rise or fall over time. In order to protect against dramatic increases in the rate, ARM loans usually have caps that limit the rate from rising above a certain amount between adjustments (i.e. no more than 2 percent a year), as well as a ceiling on how much the rate can go up during the life of the loan (i.e. no more than 6 percent). With these protections and low introductory rates, ARM loans have become the most widely accepted alternative to fixed-rate mortgages.

• Hybrid loans
  Hybrid loans combine features of both fixed-rate and adjustable-rate mortgages. Typically, a hybrid loan may start with a fixed-rate for a certain length of time, and then later convert to an adjustable-rate mortgage. However, be sure to check with your lender and find out how much the rate may increase after the conversion, as some hybrid loans do not have interest rate caps for the first adjustment period.
  Other hybrid loans may start with a fixed interest rate for several years, and then later change to another (usually higher) fixed interest rate for the remainder of the loan term. Lenders frequently charge a lower introductory interest rate for hybrid loans vs. a traditional fixed-rate mortgage, which makes hybrid loans attractive to homeowners who desire the stability of a fixed-rate, but only plan to stay in their properties for a short time.

• Balloon payments
  A balloon payment refers to a loan that has a large, final payment due at the end of the loan. For example, there are currently fixed-rate loans which allow homeowners to make payments based on a 30-year loan, even thought the entire balance of the loan may be due (the balloon payment) after 7 years. As with some hybrid loans, balloon loans may be attractive to homeowners who do not plan to stay in their house more than a short period of time.
  

• Time as a factor in your loan choice
  As has been discussed, the length of time you plan to own a property may have a strong influence on the type of loan you choose. For example, if you plan to stay in a home for 10 years or longer, a traditional fixed-rate mortgage may be your best bet. But if you plan on owning a home for a very short period (5 years or less), then the low introductory rate of an adjustable-rate mortgage may make the most financial sense. In general, ARMs have the lowest introductory interest rates, followed by hybrid loans, and then traditional fixed-rate mortgages.
  

• FHA and VA loans
  U.S. government loan programs such as those of the Federal Housing Authority (FHA) and Department of Veterans Affairs (VA) are designed to promote home ownership for people who might not otherwise be able to qualify for a conventional loan. Both FHA and VA loans have lower qualifying ratios than conventional loans, and often require smaller or no down payments.
  

• Bear in mind, however, that FHA and VA loans are not issued by the government; rather, the loans are made by private lenders but insured by the U.S. government in case the borrower defaults. Remember too, that while any U.S. citizen may apply for a FHA loan, VA loans are only available to veterans or their spouses and certain government employees.

• Conventional loans
  A conventional loan is simply a loan offered by a traditional private lender. They may be fixed-rate, adjustable, hybrid or other types. While conventional loans may be harder to qualify for than government-backed loans, they often require less paperwork and typically do not have a maximum allowable amount.

When should you refinance?
Some common reasons homeowners refinance include:

• Lower monthly mortgage payments
• Convert an adjustable rate mortgage (ARM) to a fixed-rate mortgage
• Raise funds for family expenses (i.e. college tuition)
• Pay off high-interest loans
• Home improvements

The old rule of thumb is that you should refinance your home if interest rates fall more than 2 percent. That's because refinancing usually involves most of the same closing costs (loan origination fee, prepaid interest, etc.) as the original loan. For anything less than 2 percent, the savings on your monthly mortgage payment might not be significant enough to be worth your while.

Savings vs. time
For some homeowners, though, the 2 percent rule is not as important as the time needed to break even on the refinancing. For instance, if it costs $3,000 to refinance a house, and the monthly mortgage payment is lowered by $90, it would take almost 3 years for the savings to cover the costs of refinancing.

If all the information (survey, title search, etc.) for your old loan is still current, however, the lender may be willing to waive many of the fees. In addition, you may be able to roll the closing costs of a refinance loan into the new note. In other words, you don't avoid the closing costs, but instead pay them back over time along with the rest of the loan. If you consider this option, be sure to calculate the potential savings vs. the expense of paying off a higher principal balance.

Keep in mind that refinancing usually lengthens the time it takes to pay off your house. If you are 3 years into a 30-year mortgage and then refinance with a new 30-year loan, you'll end up making payments on the house for 33 years. Nevertheless, if the monthly savings are substantial enough, you still could end up paying much less over the long haul with the new loan.

Adjustable Rate Mortgages (ARMs)
Timing can also be a factor in switching from an ARM to a fixed-rate loan. For example, rising interest rates might influence you to covert your ARM into a fixed-rate loan if you plan to stay in your house for several more years.

Conversely, you may plan to move in a year or two, and find a lender who is willing to offer you dramatic interest rate savings with an ARM. In this case (and as long as the closing costs are minimal), it might make sense to switch from a fixed-rate loan to an ARM.

Equity
Refinancing with a new loan doesn't mean you have to give up all the money you've paid towards your old mortgage. With each payment, you build up a certain amount of equity in a property--which is the amount you've paid on the principal balance of the loan.

For example, if you have a $100,000 loan at 8 percent, you would build about $2,800 worth of equity in the first 3 years. Thus, if you refinanced, the new loan would only amount to $97,200.

Raising cash with home equity loans... use caution
If you've built enough equity, you can refinance in order to take cash out of the property. Perhaps you need money to pay off your credit cards, add a new bathroom, or cover the costs of braces for a child. Regardless, lenders will typically allow you to borrow against the equity you've built in your house, plus appreciation (often up to 75 percent of the current appraised value). These types of loans are also called home equity loans.

Be cautious, however, of lenders offering 100 percent or 125 percent home equity loans--their rates are often markedly higher than traditional lenders. In addition, any amount you borrow that is above the market value of the house is NOT tax deductible.

Talk to your lender
With all the different types of refinancing loans available today, you should take some time to shop around and speak with several lenders before making a decision. Be sure to discuss all the expenses and benefits, as well as what will be expected of you, in advance. The more you educate yourself, the better your chances of finding the right refinancing package.

Deciding what length is best for you should be based on several factors including: your purchasing power, your anticipated future income and how disciplined you want to be about paying off the mortgage.

What are the benefits of a shorter loan term?
Some homeowners choose fixed-rate loans that are less than 30 years in order to save money by paying less interest over the life of the loan. For example, a $100,000 loan at 8 percent interest comes with a monthly payment of around $734 (excluding taxes and homeowner's insurance). Over 30 years, this adds up to $264,240. In other words, over the life of the loan you would pay a whopping $164,240 just in interest.

With a 15-year loan, however, the monthly payments on the same loan would be approximately $956--for a total of $172,080. The monthly payments are more than $200 more than they would be for a 30-year mortgage, but over the life of the loan you would save more than $92,000.

What are the advantages to a 30-year loan?
Despite the interest savings of a 15-year loan, they're not for everyone. For one thing, the higher monthly payment might not allow some homeowners to qualify for a house they could otherwise afford with the lower payments of a 30-year mortgage. The lower monthly payment can also provide a greater sense of security in the event your future earning power might decrease.

Furthermore, with a little bit of financial discipline, there are a variety of methods that can help you pay off a 30-year loan faster with only a moderately higher monthly payment. One such choice is the biweekly mortgage payment plan, which is now offered by many lenders for both new and existing loans.

Biweekly mortgages
As the name implies, biweekly mortgage payments are made every two weeks instead of once a month--which over a year works out to the equivalent of making one extra monthly payment (compared to a traditional payment plan). One extra payment a year may not sound like much, but it can really add up over time. In fact, switching from a traditional payment plan to a biweekly mortgage can actually shorten the term of a 30-year loan by several years and save you thousands in interest.

If you're interested in a biweekly payment plan, make sure to check with your lender. In many cases, lenders also offer direct payment services that automatically withdraw funds from your bank account, saving you the trouble of having to write and mail a check every two weeks.

Making extra payments yourself--do it early!
Another way to pay off your loan more quickly is to simply include extra funds with your monthly payment. Most lenders will allow you to make extra payments towards the principal balance of your loan without penalty. This is especially attractive to homebuyers who are concerned about their future earning power, but still want to be aggressive about paying off their loan.

For example, if you had a 30-year loan, you might decide to send the equivalent of one or two extra payments a year (which could shorten the overall length of the loan by many years). But if your financial situation suddenly took a turn for the worse, you could always fall back on the regular monthly payment.

One important note, though, is that if you do decide to send extra funds, make sure to do it EARLY in the life of the loan. This is because most home loans are calculated in such a way that the first few years of payments are almost entirely interest, while the last few years are mostly applied towards the principal balance. Thus, you can get the most bang for your buck by making the extra payments early in the life of the loan.

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