Types of Mortgages 2 | New Homes Market Center
Fixed Rate Mortgages
A fixed rate mortgage has an interest rate that stays the same over the amortization period. The 30-year fixed is the most common of the fixed-rate products. This means that the interest rate for the loan is set for the entire 30 years of the loan. This type of mortgage may carry a higher interest rate than many other products because there is less risk to you over time. There is less risk because it protects you from changes in the market – especially important when the interest rate rises. With a fixed rate, you also benefit from a fixed payment throughout the life of the loan. This is a good loan to choose if you are planning to keep the house for a long period.
Other fixed interest rate options to purchase a new home that allow your payments to remain the same over a preset number of years include the 10-year, 15-year, 20-year, and 25-year fixed rate mortgages. In general, interest rates are better on the shorter terms than on the 30-year. For these products, amortization is over the same number of years for which the loan is fixed. The shorter the loan term, the faster you are going to build equity in your house and the less interest you will pay over time. If you are concerned about a high monthly payment, but you want to build equity quickly, look for a loan with a long amortization and then plan to make extra payments towards the principle as often as you can. This will get your loan paid down in less time while not obligating you to a higher monthly payment. Talk to your lender about this option.
Adjustable Rate Mortgages (ARMs)
ARMs have an interest rate that changes based on fluctuations in the mortgage market rates or economic trends. This type of loan usually offers a much lower interest rate and shorter period than fixed products. ARMs can have fixed rates from one month to ten years. Some of the most common ARMs are 3/1, 5/1, 7/1, 10/1, or 5/6 ARMs. When a lender tells you they are quoting a 3/1 ARM, that means the interest rate is fixed for three years, and after that time, the loan becomes adjustable and can adjust once a year after that. A 5/6 ARM is a fixed loan for five years, and after the fifth year, it can adjust to the market rate every six months.
Most ARM products have an amortization period of 30 years and adjust according to one of three indexes: the libor, the US Treasury, or the cofi index. Once the loan reaches its time to adjust, it adjusts to the selected index plus the set margin for the ARM product you acquired. Margins can vary with each lender, but the most common range is 1.875 – 2.75 over the index.
Most ARMs have a rate cap so that the borrower has some protection against the payment going up too high. Here is a possible scenario. You take out a loan that has a 5/1 libor with an interest rate of 5.0 percent, a margin of 2.25, and caps of 2/2/5. This tells you that once the fixed period ends, the loan can only adjust once a year, and the initial adjustment is the margin plus the index (in this case the libor). If the libor rate is 2.0 percent at the time of the adjustment, your new interest rate for the sixth year will be 4.25 percent. Yes, it is possible that your interest rate can adjust down. However, if the libor index is at 4.0 percent, then your new adjusted interest rate would be 6.25 percent. The caps of 2/2/5 mean the interest rate can only go up or down by two percent in the first year, two percent each year after that and up or down by five percent over the lifetime of the loan.
An ARM product can be a good choice if you are not planning to live in your new home longer than three, five, seven, or ten years. You may be able to save money by getting into one of these products with a lower interest rate, but keep in mind that the longer the fixed period, the higher your interest rate will most likely be.
Interest Only Mortgages
Interest only mortgages are similar to ARMs because after a specified period of time, your required monthly payment can adjust, but you do not make any principal payments during the initial interest only period. These mortgages allow you to have a lower monthly payment. They can be especially beneficial for investment properties where your goal is to get your return from an increase in property value and are not looking to make your return by paying down the principal. If you require lower monthly payments, and would like to make other investments with your money, an interest only loan may be right for you.
A balloon mortgage has a specified amortization period but full payment is due before the end of that period. Interest rates on these products are usually lower than the 30-year fixed rate because the shorter payback period.
Stated Income Mortgage
Pricing on stated income loans is a little higher than most products because the lender does not verify any of your income. They will just look at your bank accounts and assets and, although they have programs available where you can get 100 percent financing, most lenders require at least five to ten percent down. The interest rate for a 100 percent stated income product is higher than if you put 10 percent down.
No Doc Mortgage
Lenders base no doc loans on the borrower’s credit history. The lender will not verify assets, employment, or income documentation. Lenders consider no doc loans to be risky and, therefore, may assign higher interest rates than on a full documentation loan.
There are hundreds of loan structures and mortgage options to choose from if you are purchasing a new home. Many first time homebuyers do not think they will qualify for a new home so they do not even bother to try. It is worth a try, so talk with your lender and to see if you can take advantage of available programs.