A fixed rate mortgage is the basic, straightforward loan that offers an interest rate that’s fixed for the life of the loan. The same principal and interest amount is paid every month.
Variations. The standard length of fixed rate mortgage is thirty years. but this can vary. You can own more of your home faster and pay less interest overall by paying off your loan in less than thirty years. The interest rate of a fifteen year mortgage typically is 25% to 5% lower than the interest rate of thirty-year mortgage. You can also raise or lower your monthly payments by paying points up front.
Once you’ve decided on the length of your mortgage and whether or not you will pay points, your payments remain fixed for the life of the loan.
Things to know
You should consider an ARM if you:
- Can’t afford payments on a fixed rate mortgages;
- Want to gamble that interest rates will eventually drop;
- Plan to replay the loan before it adjusts to the level of the current fixed rate.
As its name implies, an ARM is a loan that usually begins at a lower rate than that of fixed loan and is adjusted periodically to stay inline with the interest rate trends of the economy. Lenders are legally required to give you information on how ARMs work. Each ARM has a formula that determines how much your rate will rise or fall over the life of the loan.
How ARMs Work
Here is a example:
1. Determining the size of adjustment.
How often. Payments adjust periodically. Typically ARMs adjust every six monts, or every 1, 3, 5 or 7 years.
When it occurs. The adjustment must be calculated before it’s due to go into effect, typically 45 days in advance.0
Find the index. Your loan is tied to the swings of another interest rate (or combination of rates), called the index. One common index is U.S. Treasurie(e.g., 1-year T-bills).
Add a set amount. The lender adds a margin (the set percentage increase) to the index
2. Limiting the adjustment
Every ARM has built-in protections.
Star with your current rate. Apply the cap. The cap is the most your rate can rise or fall at each adjustment.
Your new rate
3.Compare to the adjusted rate.
Hold at the cap.
The rate cap saves you.
The ceiling. Also know as the lifetime cap, the ceiling is the most your rate can rise over the life of the loan. If your loan starts at 6%, for example, and the ceiling is 5%, your rate can never go above 11%.