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| Your Guide to Financing a Home |
HOME-FINANCING OPTIONS
Types of mortgages include the following:
— Fixed-Rate Mortgage
A fixed-rated mortgage comes with an interest rate that remains the same for the life of the loan. The life or term of a mortgage is 30 years by industry standards, but 15- and 20-year-term loans are also available.
— Adjustable-Rate Mortgage
Adjustable-rate mortgages (ARMs) come with interest rates that adjust up or down, depending upon current economic trends and are based on a money market index. The one-year U.S. Treasury bill is commonly used because its yield is similar to the 30-year U.S. Treasury bill used to set rates on 30-year fixed-rate mortgages. ARMs also might be tied to other indexes, including certificates of deposit (CDs) or the London Inter-Bank Offer Rate (LIBOR) among other regularly published indexes.
To come up with the ARM rate, the lender will add to the index a “margin” of usually two to four percentage points. Initially, the ARM rate is lower than the fixed rate, from about one-quarter point to two points or more, depending on the economy. The date when the first adjustment occurs (from six months to many years) and how often the rate adjusts depends on the terms of the loan. After the first adjustment occurs, subsequent adjustments can occur every six months, once a year or at longer intervals. The adjustment period is disclosed in the specific loan.
ARMs generally have limits or “caps” on how high it can adjust during each adjustment period as well as for the life of the loan. The caps protect you from drastic 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 loan or start you off with smaller payments than you’d have to pay for the same mortgage with a higher fixed rate. If index rates fall with an ARM, so does your monthly mortgage.
ARMs also could be a good choice for someone who knows that his or her income will rise and at least keep pace with the loan rate’s periodic adjustment cap. If you plan to move in a few years and are not concerned about the possibility of a higher rate, an ARM could be a sound solution.
Most lenders now are requiring that buyers use an escrow account. The lender automatically places a portion of the homeowner’s monthly note into an account specifically designated to pay for insurance and taxes. From that account, the lender is responsible for paying the annual bills.
Types of mortgages include the following:
— Fixed-Rate Mortgage
A fixed-rated mortgage comes with an interest rate that remains the same for the life of the loan. The life or term of a mortgage is 30 years by industry standards, but 15- and 20-year-term loans are also available.
- Shorter-term loans come with cheaper interest rates. A 15-year mortgage interest rate is typically one-quarter to one-half percent lower than a 30-year mortgage. Both the cheaper rate and the shorter term mean you also pay less during the life of the loan than you would if you borrowed the same amount of money with a long-term loan. However, monthly payments of a shorter-term loan 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 outlay, the shorter-term loan could be to your advantage. Whatever term you choose, fixed-rate mortgages protect you from the risk of rising interest rates. Of course, since you are locked in to a given rate, you could end up with a rate higher than necessary should rates fall.
— Adjustable-Rate Mortgage
Adjustable-rate mortgages (ARMs) come with interest rates that adjust up or down, depending upon current economic trends and are based on a money market index. The one-year U.S. Treasury bill is commonly used because its yield is similar to the 30-year U.S. Treasury bill used to set rates on 30-year fixed-rate mortgages. ARMs also might be tied to other indexes, including certificates of deposit (CDs) or the London Inter-Bank Offer Rate (LIBOR) among other regularly published indexes.
To come up with the ARM rate, the lender will add to the index a “margin” of usually two to four percentage points. Initially, the ARM rate is lower than the fixed rate, from about one-quarter point to two points or more, depending on the economy. The date when the first adjustment occurs (from six months to many years) and how often the rate adjusts depends on the terms of the loan. After the first adjustment occurs, subsequent adjustments can occur every six months, once a year or at longer intervals. The adjustment period is disclosed in the specific loan.
ARMs generally have limits or “caps” on how high it can adjust during each adjustment period as well as for the life of the loan. The caps protect you from drastic 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 loan or start you off with smaller payments than you’d have to pay for the same mortgage with a higher fixed rate. If index rates fall with an ARM, so does your monthly mortgage.
ARMs also could be a good choice for someone who knows that his or her income will rise and at least keep pace with the loan rate’s periodic adjustment cap. If you plan to move in a few years and are not concerned about the possibility of a higher rate, an ARM could be a sound solution.
Most lenders now are requiring that buyers use an escrow account. The lender automatically places a portion of the homeowner’s monthly note into an account specifically designated to pay for insurance and taxes. From that account, the lender is responsible for paying the annual bills.
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