Real Estate Loans
There are several different types of home loan programs available to the borrower today, and they break down into two basic categories — fixed rate and adjustable rate.
Fixed Rate Loans
15 – 40 Year Fixed
A fixed rate loan has a set interest rate and monthly mortgage payment that is maintained for the life of the loan. There are different terms or durations of the loan available – 15 years, 20, 25, 30, even 40 years. This would be best if you intended to stay in your home for that length of time or more, or are conservative and did not want to take a risk that the mortgage payment will increase in the future.
A balloon mortgage is a variation on the fixed rate loan. It provides for a lower initial interest rate for the first 5 – 10 years of the loan, based on an amortization of 30 years. After the initial period the loan actually becomes due or can be renewed at the current fixed rate of the market at that time. The interest rate of the initial period is typically ¼ to ½ % lower, there is generally a small fee of approximately $250 to convert the loan, and when renewed with the current lender there is generally an additional small percentage added to the fixed rate (perhaps ½ %). This program would be beneficial for someone who perhaps plans to move in the next 5 – 7 years and who wants a lower initial payment.
Adjustable Rate Loans
An adjustable rate mortgage (ARM) is a loan whose interest rate adjusts either up or down depending on current market conditions. The advantage of an ARM is that the initial interest rate is generally significantly lower than that of a fixed rate. The disadvantage is that you will not know whether or not your payments will remain the same or adjust upwards year to year. ARM loans are typically named for their adjustment interval.
For example, a 3/1 ARM is fixed for the first 3 years and then becomes a one-year ARM for the remainder of the 30-year term. A 3/3 ARM adjusts every 3 years throughout the entire 30 year term. These loans are advantageous to homeowners who expect their incomes to increase from year to year and are not hesitant about fluctuating payments, or who do not expect to be in the home for a long period. ARMS are also generally assumable to new purchasers (subject to approval) whereby fixed rate loans are not.
There are several factors that affect this type of mortgage and the rate changes:
- Index – the financial instrument used as the foundation for determining future rates as adjustments are made. There are several indexes used by the mortgage industry — Treasury Bill, 11th District Cost of Funds (COFI), the LIBOR or Prime rate.
- Margin – the predetermined amount the lender adds to the index to arrive at the adjusted rate. The index is basically the cost to the lender, and the margin is considered the “profit” or yield for the investment.
- Caps – the cap is the maximum amount the ARM is allowed to adjust in each interval and over the life of the loan. The caps can apply to the interest rate or the payment.