Real Estate:
Different types of mortgages
There are many, many different types of mortgages. But there are two most common
types of mortgages - fixed rate and adjustable rate (ARM).
Fixed Rate Mortgage:
These are also called
conventional mortgages because they have been around since the 1930's.
With this type of mortgage
your borrowing costs and monthly payments remain the same for the term of
the loan, no matter what happens to market interest rates. This
predetermined expense is one of a fixed-rate loan’s most attractive
features, since you always know exactly what your mortgage will cost you.
If interest rates rise, a fixed-rate mortgage works in your favor. But if
market rates drop, you can refinance (take out a new mortgage and pay off
your current mortgage) to get a lower rate and reduce your mortgage
costs. Fixed-rate mortgages, which are available in 15-, 20-, and 30-year
terms, are more common than adjustable-rate mortgages except in periods
when interest rates are high.
Adjustable Rate Mortgage or ARM:
ARMs started out in the 1980's
(when interest rates were very high) to help more buyers qualify for
mortgages. Unlike a fixed-rate mortgage,
where interest rate remains the same for the term of the loan, the
interest rate on an ARM is adjusted, or changed, during its term. The
initial rate on an ARM is usually lower than the rate on a fixed-rate
mortgage for the same term, which means it may be easier to qualify for
an ARM. You take the risk, however, that interest rates may rise,
increasing the cost of your mortgage. The bank is willing to give a lower
mortgage interest rate because it is "protected" from higher interest
rates in the future. Of course, it's also possible that the rates may
drop, decreasing your payments.
The rate adjustments, which are based on changes in one of the publicly
reported indexes that reflect market interest rates, occur at preset
times, typically once a year but sometimes every three, five, or seven
years. Lenders determine the new rate using two measures:
-
The index - This is often a published figure, like the rate on
one-year U.S. Treasury securities. Be sure to check the index because
some fluctuate more and change more rapidly than others.
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The margin - This is a hundredths of a percentage point added
to the index to determine the new rate.
Annual and Lifetime caps:
Typically, rate changes on ARMs are capped, meaning there is a limit
on the amount the interest rate can change. The annual cap
limits the rate change each year (2 percentage points is most common),
while lifetime cap limits the change (usually 6 percent)
over the life of the loan which helps
protect you in the case of a rapid or sustained increase in market rates.
These are important details in an adjustable rate mortgage. The
adjustment period is key to the loan. How often they adjust the payment
is important because you want the longest adjustable period. Most decent ARMs have an adjustment period of one year, so your monthly payments
remain the same for a year, then increase or decrease the next year. Be
very weary of the word "discount" when looking at ARMs as this means that
the loan will most likely have a shorter adjustment period which will
lead to a higher cost in the long run. This is similar to introductory
rates on a credit card.
If you plan to be in a house for only 3-5 years, an ARM allows
you to pay lower monthly payments for those 3-5 years than a fixed interest rate
mortgage. If interest rates drop, an ARM provides a way to participate in these
lower rates without having to refinance your house. This can save you cost of
refinancing.
However, certain ARMs allow negative amortization, which means
additional interest could accumulate on the outstanding balance if market rates
rose higher than the cap. For example if interest rates rates rise 4% one year,
but your annual cap is 1%, you owe the 3% difference. The additional interest is
added to the amount of your loan. You should avoid adjustable rate mortgages with negative
amortization!
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What is
Private Mortgage Insurance?
Private mortgage
insurance (also called PMI) is insurance provided by a mortgage
insurance company to protect a lender in the event of default on a
loan. PMI is generally required when you put less than 20% down on
a mortgage. You pay for mortgage insurance on a monthly basis in
addition to the principal and interest payments that are made on a
loan. The lender then transfers the PMI payments to the insurance
company.
The bank must drop the PMI once you have built
up more than 22% in equity. Stay on top of this and make sure they
drop it when they are supposed to. If your property appreciates
you effectively have more equity in your home. If this happens you
should ask your lender if they will drop the PMI requirement based
on the new value. In order for them to drop the PMI they will most
likely require an appraisal which will cost you around $250.
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Next -->>
More
Mortgage Choices
Table of Contents:
-
Should
you buy a home?
Renting vs. Buying:
-
Steps to buying a home
-
What is a
Mortgage and do you needed?
-
Different types of Mortgages
-
More Mortgage
Choices
-
0 to 5% down
with FHA and VA loans?
-
Cosigning: The Pitfalls
-
Qualifying for a
Mortgage
-
How much of a
mortgage and a house can you afford?
-
Finding a home with FSBOs & Real Estate Agents.
- It's closing
time: Title and the keys please!
-
Tapping your home
equity: Refinancing
-
Tapping your home equity: Home Equity Loans
-
Frequently
Asked Questions (FAQs) on Real Estate & Mortgages
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