The most common mortgage is a fixed-rate mortgage. These loans feature fixed rates and monthly payments, generally for 15 and 30-year periods. Homeowners like these loans because House payments do not rise and fall with the economy. Whenever rates are low, fixed-rate mortgages are very affordable.
Offers borrowers the chance to borrow money on a long-term basis without having to worry about the interest rates or payments changing. Monthly payments are lower than those on 15-year loans because the interest is amortized over a longer period. Lower monthly payments free up money that borrowers can use for investments that yield more than their homes. Higher interest bill increases the amount consumers can deduct at tax time, potentially reducing or eliminating their federal income tax liability.
Borrowers build equity much more quickly due to shorter amortization schedules. Overall interest bills are dramatically lower than those on longer-term loans. The interest rates are lower than 30-year loans.
Adjustable-rate mortgages, or ARMs, differ from fixed-rate mortgages in that the interest rate and monthly payment move up and down as market interest rates fluctuate. Most have an initial fixed-rate period during which the borrower’s rate doesn’t change, followed by a much longer period during which the rate changes at preset intervals. Rates charged during the initial periods are generally lower than the rates found on comparable fixed-rate mortgages. The initial fixed-rate period can be as short as a month or as long as 10 years. One-year ARMs are the most common.
ARMs — sometimes referred to as 3/1, 5/1, 7/1 or 10/1 loans — have fixed rates for the first three, five, seven or 10 years, followed by rates that adjust annually thereafter. After the fixed-rate period of time, an ARM’s rate fluctuates at the same rate as an index spelled out in closing documents. The lender finds out what the index value is, adds a margin to that figure, then recalculates what the borrower’s new rate and payment will be. The process repeats each time an adjustment date rolls around.
Most ARM rates are tied to the performance of one of three indexes: The weekly constant maturity yield on the one-year Treasury Bill. The yield debt securities issued by the U.S. Treasury are paying, as tracked by the Federal Reserve Board. The 11th District Cost of Funds Index (COFI) The interest financial institutions in the western U.S. are paying on deposits they hold. The London Interbank Offer Rate (LIBOR) The rate most international banks are charging each other on large loans. Borrowers have some protection from extreme changes because ARMs come with caps. These caps limit the amount by which ARM rates and payments can adjust.