The length is exactly that – how long the mortgage term lasts, which can be anything from 30 years down to one.
The rate itself is quite simple as well: it's the rate of interest charged during the life of the loan.
Furthermore, the rate can be either fixed or adjustable. The
definitions of each and how each could impact you are spelled out below. But if
you find yourself with more questions than answers, just give us a call at 1-800-734-REFI.
We'll help you adjust your outlook on the situation and fix-in on which might be
best for you.
Fixed-Rate Mortgages
The Basics
In a nutshell, a fixed-rate mortgage (FRM) charges a set rate of interest that does
not change throughout the life of the loan. Although the amount of principal and
interest paid each month varies from payment to payment, the total payment remains
the same. At the beginning of a fixed-rate mortgage, the payment will consist of
mostly interest with a smaller amount of principal. However, as time goes on, this
proportion will flip-flop so that you're paying more and more towards principal
and less and less to interest.
The Advantages
The main advantage of a fixed-rate mortgage loan is that the borrower is protected
from sudden and potentially significant increases in monthly mortgage payments if
interest rates rise. Fixed-rate mortgages are easy to understand and vary little
from lender to lender. The downside to fixed-rate mortgages is that when interest
rates are high, qualifying for a loan is more difficult because the payments are
less affordable.
Although the rate of interest is fixed, the total amount of interest you'll pay
depends on the mortgage term. Traditional lending institutions offer fixed-rate
mortgages in a variety of terms, the most common of which are 30, 20 and 15 years.
And we even offer a 10-year fixed-rate mortgage as well!
The 30-year fixed-rate mortgage is the most popular choice because it offers the
lowest monthly payment; however, the trade-off for that low payment is a significantly
higher overall cost because the extra decade, or more, in the term is devoted primarily
to paying interest. The monthly payments for shorter-term mortgages are higher so
that the principal is repaid in a shorter time frame. Also, shorter-term mortgages
offer a lower interest rate, which allows for a larger amount of principal repaid
with each mortgage payment, so shorter-term mortgages cost significantly less overall.
Adjustable-Rate Mortgages
The Basics
The name says it all, the interest rate on an adjustable-rate mortgage (ARM) varies
over time. The initial interest rate on an adjustable-rate mortgage (ARM) is set
below the market rate on a comparable fixed-rate loan and will stay at that level
during it's fixed period, which can last anywhere from one year to 10 years. As
a rule of thumb, the shorter the initial fixed period, the lower the initial rate.
After that fixed period, however, the rate can move higher (or lower) depending
on a number of factors. Read more on these factors in our article on How Financial Conditions Influence Rates.
ARM Terminology
As you can tell, adjustable-rate mortgages (ARMs) are a lot more complex than fixed-rate
mortgage loans. So, in order to make a good decision about whether this type of
loan is good for you, it's important that you understand a few of the basic terms.
- Adjustment Period – This refers to the amount of time between
potential interest-rate adjustments. You may see an adjustable-rate mortgage (ARM)
described with figures such as 1-1, 3-1, and 5-1. The first number refers to the
initial period of the loan, during which your rate will remain unchanged. The second
number is the adjustment period, showing how often adjustments can be made to the
rate after the initial period has ended. So, in the 5-1 example above, the initial
period will last for five years and then your rate could change on a yearly basis
thereafter.
- Adjustment Indexes – Interest-rate adjustments are tied to
a specific index, or benchmark, such as the interest rate on certificates of deposit
or (one-, three- and five-year) Treasury securities, or the LIBOR rate.
- Margin – Think of the margin as the lender's markup. It is an interest rate
that represents the lender's cost of doing business plus the profit they will make
on the loan. The margin is added to the index rate to determine your total interest
rate. It usually stays the same during the life of your home loan.
- Caps – There are two different types of caps that apply to
adjustable-rate mortgages (ARMs): rate and payment. Rate caps limit how much interest
you can be charged. There are two types of interest rate caps associated with adjustable-rate
mortgages (ARMs):
- Periodic caps limit the amount your interest rate can increase from one adjustment
period to the next. Not all adjustable-rate mortgages (ARMs) have periodic rate
caps.
- An overall cap limits how much the interest rate can increase over the life of the
loan. Overall caps have been required by law since 1987.
- A payment cap does just that: limits how much your monthly payment can increase
at each adjustment. Adjustable-rate mortgages (ARMs) with payment caps often do
not have periodic rate caps.
- Carryovers – If an interest rate cap held your interest down at an adjustment
even though the index went up, the amount of the increase can be carried over to
the next adjustment period.
- Discounted Rates and Buydown – When you're buying a home
you might encounter sellers who offer to pay a "buydown" fee that allows the lender
to offer you an initial rate that's lower than the sum of the index and the margin.
New home builders sometimes offer that type of purchase package to help get people
into their homes. The buydown rate will eventually expire and your payments could
rise significantly if your adjustable-rate mortgage (ARM) rate is adjusted upwards
at the same time the discount expires.
The Bottom Line
As you can see, there are definite pros and cons to each type of mortgage –
fixed-rate mortgages and adjustable-rate mortgages (ARMs). A traditional fixed-rate
mortgage provides the security of an unchanging payment, immunity to rising rates
at the expense of a higher initial payment and longer terms. Adjustable-rate mortgages
(ARMs) are attractive to those who want low initial payments, don't plan on living
in the home long enough for the rates to rise, or are confident that present high
rates are going to fall. You must balance this with the knowledge that once your
initial period ends, your rate could increase and you could be saddled with a much
larger payment. Plus, the future could also hold more increases depending which
way your loan's adjustment index is headed when the next adjustment date hits.
We've just supplied you with a lot of information. We're hoping that it's cleared
your picture of what to expect out of both types of mortgages. If you've still got
questions or would like to find out how our loans could help you get into your dream
house, give us a call at 1-800-734-REFI. We're here to help.
