Mortgage Loan Options
Once again (for clarity), the two most common types of loans
are Fixed-Rate Mortgages and Adjustable-Rate
Mortgages, known as ARMs.
A fixed-rated mortgage comes with an interest rate that
remains the same for the duration of the loan.
The life or term of a mortgage is 30 years by industry
standards, but 10, 15 and 20-year term loans are also
available.
Shorter term loans usually come with cheaper interest rates.
A 15-year mortgage's interest rate is often one-quarter to
one-half percent lower than a 30-year mortgage. Both the
cheaper rate and the shorter term mean you'll also pay less
interest over the life of the loan than you would if you
borrowed the same amount of money with a long term loan.
Monthly payments of a shorter term loan, however, are
generally higher than the same loan for a long term because
the larger payments of the short term loan are necessary to
repay the debt sooner.
A long term loan with smaller monthly payments can be easier
to budget, but if you have a stable salary that allows you
to afford the larger monthly payments, the shorter term loan
could be advantageous.
Fixed rate mortgages protect you from the risk of rising
interest rates and higher payments. Of course, since you are
locked in to a given rate, you could end up with a rate
higher than the going rate should interest rates fall.
The second most common mortgage is an ARM. The
interest rates can adjust up or down, depending upon current
economic trends.
An ARM's rate is based on a money market index. The one-year
U.S. Treasury bill is often used because it's yield is
similar to the 30-year U.S. Treasury bill used to set rates
on 30-year fixed mortgages. ARMs might also be tied to other
indexes, including certificates of deposit (CDs) or the
London Inter-Bank Offer Rate (LIBOR) rates, among other
regularly published indexes.
To come up with the ARM rate, lenders add a "margin,"
usually two to four percentage points, to the index.
Initially, the ARM rate is lower than the fixed rate, from
about a quarter point to two points or more, depending upon
the economy. When the first adjustment occurs (from six
months to many years) and how often the rate adjusts,
depends upon the terms of the mortgage. After the first
adjustment occurs, subsequent adjustments can occur every
month, six months, once a year, or during longer periods.
The adjustment period is disclosed in the terms of the
mortgage.
ARMs typically have limits or "caps" on how high it can
adjust during each adjustment period as well as over the
life of the loan.
The caps protect you from fast market changes, but ARMS
don't offer the stability of a fixed rate loan.
ARMs' lower initial rate, however, can help you qualify for
a larger home or start you off with smaller payments than
you'd have to pay for the same mortgage with a higher fixed
rate. And if index rates fall with an ARM, so does your
monthly mortgage.
ARMs could also be a good choice for someone who knows their
income will rise and at least keep pace with the loan rate's
periodic adjustment cap. If you are planning to move in a
few years and are not concerned about the possibility of a
higher rate, an ARM also could be a good choice.
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