Different Types of Loans and when to use them

Variable Interest Rate: A variable interest rate loan, often referred to as an ARM (adjustable rate mortgage) is a mortgage that has an interest rate that can adjust. Typically, the interest rate is tied to an index (Prime, LIBOR, COFE) and will move with the index rate. The amount that the interest rate can adjust, and even when it can adjust, varies with the different loan programs out there.

A Variable Interest Rate should be used when market rates are declining and/or stable to keep your payment and rate lower than it would be fixed, or if you are going to be holding onto the property for a short period of time.

Interest-Only Loan: An interest only loan is a loan where the minimum payment you are required to make pays only the interest on the loan. In essence, if you make the minimum payment on a property for 10 years, you’ll end up oweing exactly the same amount as you originally had owed the bank.

An interest only loan is commonly found in Home Equity Lines of Credit, but I would always recommend paying additional principle. As far as when interest only loans should be used, I would recommend using them on investment properties where you need as much cash flow as possible – a property that you are not planning on holding for a very long period of time. An example would be if you were to purchase a foreclosed property and needed to keep your payments as low as possible so you were able to put the extra cash towards fixing up the home.

Negative Amortization: A Negative Amortization loan requires a minimum payment of less than the interest you accrue each month. If you make only your minimum payment, you will actually owe more on the property each month than the month before. Negative Amortization loans should only be used in situations where cashflow is very, very important and you will only hold the property for a very short period of time. It goes without saying that you would only want to use it on a property that you were able to get a substantial profit from – keep in mind, you’ll owe more on the property than you originally had taken out the loan for.

Fixed Rate Loan: A fixed rate loan is a loan that has a fixed rate for the life of the loan. The rate will not change, regardless of what the market does.

A fixed rate loan should be used when you are planning on holding the propety for a long period of time, or when payment stability is very important to you. Fixed rate loans are considered the most stable, conservative, and safe type of mortgage loan out there.