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A fixed rate mortgage is the most common type of mortgage program. When you have a fixed rate mortgage your monthly rates will be very stable, changing only if your property taxes and homeowners insurance change.
Fixed-rate mortgages are available for 30, 20, 15 or 10-year periods. Fixed rate fully amortizing loans have two distinct features. First, the interest rate remains fixed for the life of the loan. Secondly, the payments remain level for the life of the loan. The most common fixed rate loans are 15-year and 30-year mortgages. During the early amortization period, a large percentage of the monthly payment is applied to interest and under a typical 30-year fixed rate mortgage it takes 22.5 years of level payments to pay half of the principal of the original loan amount.
Adjustable rate mortgages generally begin with an interest rate that is 2-3 percentage points below a comparable fixed rate mortgage. This could allow you to buy a more expensive home, while keeping your payments within your designated payment frame for a set period of time. However, the interest rate will change at specified intervals (for example, every year) depending on changing market conditions -- if interest rates go up, your monthly mortgage payment will go up, too. But, if rates go down, your mortgage payment will also drop.
There are also mortgage options available that combine aspects of fixed and adjustable rate mortgages –- starting at a low fixed-rate for seven to ten years, for example, and then adjusting to market conditions.
Balloon loans are short-term mortgages that have some similar features of a fixed rate mortgage. The loans provide a level payment feature during the term of the loan, but as opposed to the 30-year fixed rate mortgages, do not fully amortize over the original term of the loan. At the end of the loan term there is a remaining principal loan balance and it is generally required that the loan be paid in full, which can be accomplished by refinancing your loan. There are option features offered with many balloon mortgages, such as a conversion feature at the end of the term.
Balloon loans can have many types of maturities, but most balloons that are first mortgages have terms of 5 to 7 years.
Most adjustable rate loans (ARM’s) have a low introductory rate, which can sometimes be as much as 5.0% below the current market rate of a fixed loan. This start rate is usually good from 1 month to as long as 10 years. As a rule the lower the introductory rate the sooner the loan will have its first adjustment.
Index – The index of an ARM is the financial instrument that the loan is “tied” to, or adjusted to. The most common indices, or indexes are the 1- Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month Certificate of Deposit (CD) (MTA) Monthly Treasury Average and the 11th District Cost of Funds (COFI). Each of these indices moves based on conditions of the financial markets.
Margin – The margin is one of the most important aspects of ARMs because it is added to the index to determine the interest rate that you pay. The margin added to the index is known as the fully indexed rate.
Interim Caps – All adjustable rate loans carry interim caps. Many ARMs have interest rate caps of six-months or a year, but there are loans that have interest rate caps of three years. Interest rate caps are beneficial in rising interest rate markets, but can also keep your interest rate higher than the fully indexed rate if rates are falling rapidly.
Payment Caps – Some loans have payment caps instead of interest rate caps. These loans reduce payment shock in a rising interest rate market, but can also lead to deferred interest or “negative amortization”. These loans generally cap your annual payment increases to 7.5% of the previous payment.
Lifetime Caps – Almost all ARMs have a maximum interest rate or lifetime interest rate cap. The lifetime cap varies from company to company and loan to loan. Loans with low lifetime caps usually have higher margins, and the reverse is also true. Those loans that carry low margins often have higher lifetime caps.
Buydown Options – The most common buydown is the 2-1 buydown. In the past, for a buyer to secure a 2-1 buydown they would pay 3 points above current market points in order to pay a below market interest rate during the first two years of the loan. At the end of the two years they would then pay the old market rate for the remaining term.
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