Mortgage Rate Options
Fixed Rate Mortgages
The most commonly used loan program is the traditional fixed rate mortgage, where the borrower makes consistent monthly payments of principal and interest that remain unchanged throughout the loan term. This mortgage type is available in terms of 10 to 30 years, and borrowers can usually pay it off without penalty. The mortgage is structured to be fully amortized by the end of the loan term.
Although the interest rate remains fixed, the monthly payment may fluctuate if the borrower has an “impound account.” Some lenders collect additional funds each month to cover the prorated cost of property taxes and homeowners insurance. The extra money is deposited into an impound account, which the lender uses to pay the borrower’s property taxes and insurance premium when they become due. If there is a change in property tax or insurance cost, the monthly payment will be adjusted accordingly. Nonetheless, overall payments in a fixed rate mortgage are typically steady and foreseeable.
Adjustable Rate Mortgages (ARMs)
Loans known as Adjustable Rate Mortgages (ARMs) have an interest rate that can vary over the loan’s duration. These loans commonly offer a fixed interest rate for a certain period, after which it can change according to the current market conditions. The initial rate for an ARM is usually lower than a fixed-rate mortgage, enabling borrowers to buy more expensive homes. ARMs usually amortize over 30 years, with the initial rate fixed for a duration ranging from 1 month to 10 years. All ARM loans have an “index” and a “margin.” The margin on a loan ranges from 1.75% to 3.5%, based on the index and the loan’s amount financed compared to the property value. The index is the financial instrument to which the ARM loan is linked, including 1-Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month Certificate of Deposit (CD), and the 11th District Cost of Funds (COFI).
When an ARM loan adjusts, the margin is added to the index, and then the new interest rate is typically rounded to the nearest 1/8 of one percent. This new rate will be fixed for the next adjustment period, which can be yearly. However, there are limits on how much the rates can adjust, which are called “caps.” For instance, a “3/1 ARM” with an initial cap of 2%, a lifetime cap of 6%, and an initial interest rate of 6.25% could have a maximum rate of 8.25% in the fourth year and a maximum rate of 12.25% during the loan’s term.
Interest Only Mortgages