If you are looking for a home mortgage program you will soon realize that there are several programs available to you to choose from as a home buyer. I will discuss two home mortgage programs which are the most common home loans that are applied for.
Fixed-Rate Mortgage
The widely used home mortgage program by homeowners is the fixed-rate mortgage. The monthly payment of a fixed rate mortgage consists of interest and principal pertaining to the mortgage and these payments don’t change for the life of the loan.
Sometimes it changes a little if there is a change in your homeowner’s insurance or property tax but overall your fixed rate mortgage payments should maintain steady.
But what if the market interest rate changes, you might ask? The interest rate with a fixed mortgage remains the same for the full term of your loan so that means if the market changes and they offer an even lower rate you want to be able to change it and take advantage of it. But on the bright side, your interest rate won’t increase if the market interest rate goes up, and then you are safe.
There are three common periods you can choose from and they are as follow:
- 15-year fixed rate mortgage
- 20-year fixed rate mortgage
- 30-year fixed rate mortgage
Is the “Fixed-Rate Mortgage” Right for You?
This type of mortgage is most suitable for homeowners who are planning to stay in their homes for a fairly long time (5 years or more). Staying for five or more years gives you the chance to build up equity in your home and maybe at a later time will be the right time to sell your home.
And remember in the beginning period of your loan (we’re talking about the first few years!) most of the payment amount goes toward the interest and not your principal but as the years pass you will start paying off your principal with a larger percentage and less going towards the interest.
Many home owners would like to pay off more than the required monthly payments so they can lower the interest and pay it off as soon as possible so the subsequent payments can be applied toward the principal only. And that way you can build your home equity more efficiently. However??????
Important to Know!
Yes, however, many banks, mortgage companies, and other lenders will penalize you for making overpayments or if you are trying to pay off the loan before the due date. For example, if you have a 30-year fixed rate mortgage and you are trying to pay it off within 20 years, then the lender probably will charge you a penalty fee if there is a clause in the contract stating that. You need to realize that the lender makes a profit from the interest he is charging you.
Even if you think that paying off your loan earlier is far from reality because of your recent financial situation, it is always better to have the flexibility in your contract to do so without any penalty, because you never know how things will happen in life where your financial situation can improve. This way if your lender will penalize you then you can find another one before signing your home mortgage contract.
Adjustable-Rate Mortgage (ARM)
As the name above indicates, the interest rate is not permanent but changes over time. What makes the adjustable-rate mortgage appealing to many loan borrowers is because of its initial low interest rate and the key word here is “initial”! Because after the initial period, the interest rate will change based on the market’s rate and that can be risky.
The initial period is an average of three to five years but it can be longer or shorter so you need to find out what choices the lender can offer to you. The shorter the initial period is the lower the interest rate becomes.
When an ARM is an Advantageous
1- If you intend to sell the home before the ARM’s initial period expires
2- If you plan to refinance before the ARM’s initial period expires where you can get a decent low interest rate that is fixed and predictable.
When an ARM is disadvantageous
If you have no idea how long you will be staying in your home or you are thinking about staying longer than ARM’s low interest rate initial period.
In some situations when an ARM’s interest can end up with deferred interest or negative amortization which basically means that the mandatory minimum payment is not enough to cover the interest owed. And you can end up owing more than the original loan.
**Make sure you discuss these “overlooked” or “not even aware of” issues**
What Happens After the Initial Period?
Most likely the interest rate will go up depending on the index the lender follows. An index is a rate that is put on by the existing financial conditions and is published by an unbiased and independent resource plus a margin that represents the lender’s profit. Some of the main indices are:
- Hybrid ARMs
- London Interbank Offered Rate (LIBOR)
- 12-Month Treasury Average (MTA)
-11th District Cost of Funds Index (COFI)
- Option ARMs
- Convertible ARMs
- Constant-Maturity Treasury (CMT)
Few More Words About ARMs…
- An adjustable-rate mortgage has a cap or limit on how much an interest rate can fluctuate after your initial low rate expires. This cap law was implemented to protect the borrower from not paying an exceedingly high interest rate and not as frequently.
- Just imagine after your initial low interest rate expires and the lenders decides to change your rate as frequently as every month and the interest rate jumps from 1% to 3%!
- There is usually an annual or semi-annual increase of the interest rate which is called the “periodic cap” and the other limit is over the lifetime of the loan which is also called the “overall cap”.
Here is an example of an interest rate adjustment of a loan…
If you see a code like that ½, 2, 5
½ means a loan has ½% limit on the first adjustment.
2 means a loan has 2% limit on the next adjustment.
5 means a loan has 5% limit over its lifetime.
Make sure you discus all the above points and to look carefully at the interest rate adjustment of your loan. Ask them about other issues or changes just to make sure you know what to expect.
