Fixed Mortgages Versus Adjustables
Fixed-rate mortgages
With this type of mortgage, the interest rate is fixed for the entire term of the loan. Your monthly payments for interest and principal never change. Changes in property taxes and homeowners insurance, usually a part of your monthly payment, may increase or decrease that payment amount, but generally your mortgage payment will be very stable.
Key advantages: predictability, essentially you know what your mortgage payments will be for the life of the mortgage.
Key disadvantage: higher interest rate (compared to initial rates of adjustable-rate mortgages)
Types of fixed rate mortgages
30-year Fixed Rate Mortgage
This very conventional loan offers the lowest monthly payments of any of the common fixed-rate loans.
Why this loan: for people planning to remain in the home for many years and wishing to keep housing expenses consistent.
15 year Fixed Rate Mortgage
This loan has a shorter life-15 years. Because the loan is shorter, you’ll pay less than half the total interest of a 30-year mortgage. However, because you repay the loan in half the time, the monthly payments are higher than those of a 30-year mortgage.
Why this loan: for people who can afford the higher monthly payments, it allows you to own your home before your children start college or before you reach retirement.
Biweekly Mortgage
This is usually a 30-year fixed rate mortgage. What’s different is that payment for half the monthly amount is made every two weeks. In this way, you make the equivalent of 13 months worth of payments every year. Also, because your payments are applied to the loan every 14 days, the principal amount decreases faster, saving even more in interest costs. As a result, your loan term can shorten to 18 or 22 years, providing a substanctial decrease in total interest costs.
Why this loan: for people who are paid every two weeks and are willing to make a half payment from each paycheck, this loan offers rapid building of equity.
Adjustable –Rate Mortgages
Adjustable-rate morgages (ARMs)
have an interest rate that changes at specified intervals. If interest rates go up during that time, so will your monthly mortgage payment. By the same token, if rates go down, your mortgage payment will also drop.
With an ARM, you and your lender share the potential risks of changes in interest rates. As a result, an ARM offers an initial interest rate that can be as much as two to three percent lower than a comparable fixed-rate mortgage.
Developed when interest rates were high, ARMs remain a good choice for thowe who expect their income to increase, who don’t expect to be in their home for a long time, and generally when interest rates are relatively high. However, because the interest rate can increase, you must have the resources to keep up with possible changes in your mortgage payment.
Key advantages: lower initial interest rate compared to fixed-rate mortgages, which can make homeownership more affordable and make qualifying for a mortgage easier. If interest rates decline, your mortgage payments decline as well.
Key disadvantages: the potential for higher monthly payments if interest rates increase.
A little more about ARMs
There are four basic “ingredients” in all ARMs, and different mortgages combine themin different ways. While your lender can tell you more about the ARMs available in your area, here are some helpful definitions.
Initial Interest Rate
The benchmark for your loan, it will typically be two to three percent lower than a comparable fixed-rate mortgage.
Index
The economic indicator used to determine changes to your ARMs interest rate. Your loan is tied to this index. As that number rises and falls, so does your interest rate. An example of an index commonly used for ARMs is the yield on a one-year treasury bill (T-bill). Most Arm loans generated in the last two or three years though, are based on the 6 month Libor or London Interbank Offered Rate.
Margin
The percentage points the lender adds to the index to establish the actual interest rate of your ARM. The margin remains fixed.
Adjustment Interval
The time between changes in your ARMs interest rate. If your ARM has an adjustment interval of three years, your rate-and your monthly payment-will be changed every three years, based on the current index plus your margin. Typical ARM adjustment intervals are one year, three years and five years.
In addition, an ARM may contain certain safeguards that limit the risk of sharply higher payments. One type of safeguard, called a periodic cap, limits the amount by which the interest rate can change at each adjustment. This may be combined with a limit on how much the rate can change over the life of the mortgage, called the lifetime cap.
For example, if your ARM has a periodic cap of two percent and a lifetime cap of five percent, your interest rate will not change by more than two percent at any single adjustment, and will never be more than five percent above your initial interest rate.
A payment cap is another type of safeguard that limits the increase in your monthly payment to a specific dollar amount (for example, $300) while this is more easily understood, it has a definite downside: it can prevent your monthly payment from increasing enough to match a rapidly increasing interest rate. If this happens, your payments will not be “keeping up“ with the loan schedule (that is, you are neither reducing the principal nor paying the entire monthly interest figure).
That could result in higher payments, more payments or a balloon payment later on. |
