Fixed and Adjustable Rate
Mortgages What You Need To Know B |
By John R. Blakefield |
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The dominating and most popular interest rates used when considering
a mortgage are fixed rate and adjustable rate mortgages (also known
as ARM or variable rate mortgage). Choosing the type of interest
rate for you should be used based on personal criteria and what it
is you want to achieve with your monthly payments.
Adjustable
rate mortgage are loans that a borrower pays an interest rate on the
loan amount that changes based on specific indexes that the lender
chooses. Lower monthly payments are offered at first then the
monthly payment might be higher or lower based on the interest rate
of the index at that time. The adjustment period, or the period
between the change of interest rate may be decided between you and
the lender. However, the adjustable rates often change based on a
six month, one year, three year, five year, or even seven year
period.
Adjustable rate mortgages are a good choice for those
who may be in the following positions. You should choose an
adjustable mortgage rate if there are unpredictable interest rates,
making a fixed rate difficult to obtain or if you are willing to
bear the risk for the possibility of the interest rate increasing
and are rewarded by an initially lower rate. The person who chooses
this type of rate must realize that interest rates do change often,
and if they go up, your payment may be higher than the original rate
dictated, and may be lower if the interest rate decreases.
It
is important to prepare yourself for these possible changes in the
market so a monthly payment that is considerably higher or lower
after the adjustment period does not come to a shock, whether
positive or negative, to your personal finances.
So how
exactly is this adjustable rate mortgage determined The
original interest rate may be chosen based on an index, or a
publicly published financial index such as treasure securities or
national or regional average costs of funds of savings and loans
associates. A margin is then added to the index determining the
interest rate. The margin is usually the lenders' profit above the
financial index.
If the original interest rate is offered at
an extremely low rate, then the lender may be offering you a
discounted rate, which temporarily maintains your monthly payments
low for a specific introductory period then changes according to the
index rate and adjustment period.
When considering an
adjustable rate mortgage, it is important to compare the terms,
which may include, the index that is being used to determine the
rate, initial change cap, the periodic cap, lifetime cap, what the
margin is and if the margin is variable or constant over the life of
the loan, and if you have the option to convert your loan to a fixed
rate loan at a future time.
Caps are limits that are set on
the interest rates of the loan. They are always available to the
borrower and are expressed in the following fashion: 2/2/5. The
first number is the initial change cap, which is the limit set on
the interest rate for the first adjustment period. The second number
is the periodic cap, which is the limit set on the interest rate for
every subsequent adjustment period. And the third number is the
lifetime cap, or the total limit set on the rate for the life of the
loan. It is often set at 6% for the first mortgage but may vary
depending on the loan. Of course, the lower the numbers the better
for the borrower. Always be sure to ask the lender this information
so you can make an educated decision on if the specific adjustable
loan is going to work for your financial situation.
A fixed
rate mortgage is a loan where the interest rate remains the same for
the life of the loan. The initial interest rate is often higher than
an adjustable rate, but produces stable monthly payments. A fixed
rate mortgage is good for those who want to always have the same
monthly payment and don't want to risk having a higher monthly
payment or benefit from a lower monthly payment that an adjustable
rate may produce.
When considering a fixed rate loan, it is
important to look at the terms which may include interest rates,
monthly payments and fees. A fixed rate loan is simpler than an
adjustable rate loan, but still you must look at the interest rate,
the margin, and any fees or points that you may have to pay the
lender in exchange for borrowing the loan amount. Always ask about
fees and points because they may not be clearly outlined or
expressed when first considering a loan. Or, they may need to be
added to the interest rate directly advertised to the borrower. You
do not want to agree to a fixed rate loan, and then be surprised by
a fee or points that were not added originally, but were disguised
in small print.
Recently, a "hybrid" adjustable rate mortgage
has developed. This "hybrid" rate has an introductory rate for a two
year period, or three, five, or seven year period, then becomes a
six month adjustable rate mortgage after this time period, rather
than every two years. This specific rate is good for those who are
planning to move within seven years, or simply want to live in a
more expensive home that may beyond his or her abilities to qualify
for a fixed rate loan, or live in an area where home values rise
quickly.
With both adjustable and fixed rate mortgages, you
should compare other terms such as prepayment penalties or due on
sale clauses. Prepayment penalties are fees that are paid to the
lender for paying the loan before the life of the loan is finished.
The lenders are, in essence, earning what they would if you paid the
interest for the rest of the life of the loan beyond the date when
you paid the loan in full. A due on sale clause simply states that
the borrower must pay off the entire loan if he or she sells the
mortgaged property. These terms may or may not be part of the
mortgage, but it is important to know every aspect of your mortgage,
whether or not it is a fixed rate or adjustable rate mortgage. This
can save you the costs of choosing a mortgage that is not right for
your personal situation. |
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