With a fixed-rate mortgage, your interest rate and your monthly payment of principal and interest will stay the same for the entire term of the loan. This type of mortgage tends to be the most popular because it protects homeowners from the possibility of future monthly payment increases (a situation faced by borrowers who select an adjustable-rate mortgage).
• You will know exactly what you will pay toward principal and interest every month for the entire length of the loan, which makes it easier to budget. • If interest rates go up, you will be protected. Your rate (and your principal and interest payment) will stay the same.
• If interest rates go down, your rate (and principal and interest payment) will stay the same unless you refinance.
When might a fixed-rate mortgage make sense?
• If you plan on owning your home for 7 years or more.
• If you have a monthly budget you need to stick to and prefer payment stability.
(Keep in mind that property tax and homeowner’s insurance payments can fluctuate throughout the life of your loan, but your monthly principal and interest payment will never change
Fixed-Period Adjustable-Rate Mortgage (ARM)
A fixed-period ARM is an adjustable-rate mortgage that features an initial fixed interest rate period, typically of 3, 5, 7 or 10 years. After the fixed-rate period expires, the interest rate becomes adjustable for the remainder of the loan term. Fixed-period ARMs are often named by the length of time the interest rate remains fixed.
Example: In a 5/1 ARM, the “5” stands for the five-year “introductory period,” during which the interest rate remains fixed. The “1” shows that the interest rate is subject to adjustment once per year after the introductory period and for the remainder of the loan term.
About the introductory period: The rate on this kind of loan tends to be lower during the introductory period, which could mean a lower starting monthly payment. When the introductory period ends, your rate will go up or down depending on the established margin and changes in market interest rates. If you’re considering an ARM, carefully consider your ability to handle potential increases to your rate, and consequently, your monthly principal and interest payment.
Caps: ARMs have two kinds of rate caps.
• Adjustment caps limit how much your rate can go up or down in any single adjustment period, regulating how much your loan payment can change when it adjusts.
• Lifetime caps establish a maximum and minimum interest rate over the entire life of a loan.
Many caps allow a significant increase in each adjustment period and over the life of the loan, so despite having a cap, the increase in the monthly payment allowable under the cap may make it difficult, or even impossible, for you to pay your mortgage on time if interest rates rise. If you’re considering an ARM, find out what the caps would be and then run the numbers to see if you could still comfortably afford the monthly payments allowable under the rate caps.
• ARMs generally offer lower rates during the introductory fixed rate period than fixed-rate mortgages.
• After the introductory period’s fixed rate expires, the rate is subject to adjustment. The rate could increase at this point, which would also raise your payments. A significant increase can make paying your mortgage on time more difficult.
• If you choose this kind of loan, be sure it includes an adjustment cap and/or lifetime interest cap. Keep in mind that many adjustment or lifetime caps would still result in a significant increase in your monthly payment. For example, if you had a 5/1 ARM with a starting interest rate of 4.0% (and interest rates rose), and your rate increased by two percentage points in the first two adjustment periods, by year 7, your interest rate would be 8.0% – so, your monthly payment would double from the starting monthly payment. Ask for details and plan accordingly.
When might an ARM make sense?
• An ARM might make sense if you believe interest rates will go down in the future. However, if rates are currently low, it may be more likely that rates will increase. It’s important that you are confident that you can afford the monthly payment if the interest rate adjusts upward to the maximum amount possible with this mortgage.
• An ARM might also make sense if you plan to sell the home before the introductory period ends. Of course, there is an element of risk in this plan, as it can be difficult to predict exactly how long it will take for a home to sell.
Federal Housing Administration (FHA) Loans
These government-insured loans could be a good fit for homebuyers with limited income and funds for a down payment.
• This kind of loan is helpful for applicants who don’t have a 20% down payment saved. • These loans can also help applicants who need more flexible income or credit requirements. Be aware that minimum credit scores apply so not all applicants will qualify.
• There’s a maximum loan amount, which can vary depending on where the home is located.
• FHA loan programs typically require you to pay both an upfront mortgage insurance premium (UFMIP) and a monthly mortgage insurance premium (MIP). You’ll need to factor in these premiums when you set your budget.
• There tends to be a more complex approval process for an FHA loan, and there is often more paperwork to fill out.
• An FHA loan may help get you into a home, but it’s important to be sure that the total monthly payment that comes along with the loan is one you can comfortably afford.
Jumbo loans (also known as non-conforming mortgages) exceed loan limits set by government-sponsored entities FannieMae and FreddieMac, or conforming loan limits set by the Federal Housing Finance Agency. These government agencies purchase the underlying securities from mortgage originators. Anything below the limit set by the government is considered a conforming loan eligible for purchase, while loans above that limit are non-conforming jumbo loans and are subject to slightly higher interest rates. The current jumbo loan amount is anything above $424,000.
A larger down payment, higher FICO scores and lower debt-to-income ratios may be required because the loan amount being given by the mortgagor is much higher than the average loan amount.
Jumbo loans enable you to finance large portions of a jumbo property versus putting very large down payments on jumbo loan transactions to meet the conforming loan limits.