A Fixed Rate Mortgage is one in which the rate remains the same
across the life of the loan. The advantage is that monthly
payments will remain the same. However, if you lock into a
higher interest rate, the rate will not change, even if interest
rates go down in the future.
The lowest monthly payments come from 30-year fixed-rate
mortgages. However, these mortgages also take longest to build
up equity in your home. Experts recommend a 30-year mortgage if
you are planning to stay in your home for several years and want
a stable rate.
Also common are 15-year fixed-rate mortgages. These loans spread
the principal and interest across a 15-year period, after which
you have paid off your loan. Because of the shorter term of the
loan, you can build up equity in your home at a much faster
pace. However, monthly payments are higher than for a 30-year
fixed-rate mortgage. Experts recommend a 15-year fixed-rate
mortgage if you are planning to sell your home in a few years
and want a stable rate.
Adjustable-Rate Mortgages, or ARM’s as they
are commonly called, are ones in which the interest rate changes
periodically according to a fixed index. A 1-year ARM adjusts
the interest rate annually. Monthly payments will increase or
decrease along with the index rate, which is specified by the
mortgage. Common indices include 1-year Treasury notes, Federal
funds rate and the national cost of funds index. A margin --
usually one or two percentage points -- is added to the index
rate.
Adjustable-rate mortgages include two caps on the amount the
rate can increase or decrease. One cap limits the interest rate
adjustment in any one adjustment period (e.g. one year in a
one-year ARM), and the second cap limits the interest rate
adjustment across the lifetime of the loan.
The advantage of an adjustable-rate mortgage is that monthly
payments can decrease when the index goes down. However, monthly
payments will increase when the index goes up.
One way of shortening the length of your
mortgage is to purchase a balloon mortgage. It works like an ARM
or a fixed-rate mortgage for the first several years. After that
period of time has expired, you owe a large payment -- sometimes
the remaining balance on the loan. The advantage of this type of
loan is that it keeps monthly payments low. Experts recommend
this type of loan for people who are planning to sell their
homes within a few years, and can pay off the balloon payment
from the proceeds of the sale of the house.
A convertible loan is an ARM that can be converted to a
fixed-rate mortgage after a specified number of years. There may
be a cost associated with this.
