If you want to avail of a home loan, then you need to be aware of all terms, terminologies and the factors affecting home loans, such as the place you live, the duration you plan to stay there (if applicable) based on which you can choose and shop for the perfect housing loan. Choosing wisely could help you save handsome funds on your down payment, interest rates, and other fees. Here’s the lowdown on the types of home loans for you.
Fixed rate loans
Fixed rate home loan is the most popular type of loan that gets you a single interest rate along with the monthly payment for the whole span of loan that usually can range from 15 to 30 years. This traditional home loans often feature lower interest rates in comparison with VA loans, jumbo loans, and FHA loans.
Fixed rate loans are perfect for the homeowners who plan for a long stay at a place; you have to pay the specific fixed amount for a fixed loan tenure. The peculiarity of this kind of loan is that the interest rate rise and fall won’t be affected by your loan amount monthly repayments. Most popular fixed-rate mortgages are 30 year and 15 year fixed rate mortgages. While the 30-year scheme suits for those who would like to shop their loans with lesser monthly payments, 15 year fixed rate mortgages for those who would like to pay off faster with higher EMIs.
As per the current market rates, on a 30 year fixed rate mortgage loan for $150,000 at an interest rate of 4.25%, the monthly payments would be $737.91. At the same time, conventional fixed 15-year scheme demands $1,072.33 monthly payments on a loan amount of $150,000 at 3.50% interest rate. (The payment examples excludes the amounts for taxes and insurance premiums)
As mentioned earlier, the conventional type of loan can be found useful for long-term stay house owners, in case you plan to move relatively soon, the next option could be the best to consider.
Adjustable rate mortgage (ARM)
The ARM which is also called as floating rate or variable rate mortgage, this kind of loan offers typically lower interest rate than fixed rate loan for the duration of 5 to 10 years. After this period, your loan interest rate and monthly EMI will adjust on a yearly basis as per the current interest rates. It has to be noted that if the interest rate hikes, your monthly payments also will increase and fortunately if the interest rate slashes, it will reflect as a reduction on your monthly home loan repayments. Resets in the interest rate are based on the index or benchmark along with an additional spread commonly known as ARM margin. Adjustable rate mortgage loans are right for those who possess lower credit score.
ARMs at expressed in terms of two numbers, most commonly the first number is the indicator of the duration for which a fixed interest rate is applied to the loan, even though there exists no predefined formula stating the meaning of the second number. 3/27 ARM and a 2/28 feature a fixed interest rate for three or two years respectively, followed by floating rate for the remaining 27 or 28 years. On the other hand, a 4/1 ARM says about a fixed rate for five years which is followed by a varying interest rate that adjusts on a yearly basis; this is the indication of number one. Similarly, 4/4 ARM maintains a fixed rate for the first four years and then adjusts every four years. Contrary to that formula, 4/6 ARM has a fixed rate for four years, and then it gets adjusted every six months. With the help of various mortgage calculators, it becomes a simple job to compare various types of ARMs.
ARM interest rate increase or decrease at the close of fixed rate period with respect to the benchmark and a set margin. Most of the cases, mortgages are bound to one of these indexes: the majority yield shown on one-year treasury bills, 11th district cost of funds or London Interbank offered rate. Although index rates are subjected to change, the margin remains the same. If the index is 6% and the margin is 2%, the rate of interest on the mortgage adjusts to 8%. However, if the index is at 2%, at the next revision of interest rate, it falls to 4% on the basis of the loan’s margin of 2%.
ARM usually comes with the rate caps that ensure the limit of how high the interest rate may hike or how drastically are the payments subjected to change. The periodic rate caps limit of the extent of change from one year to the next. The lifetime rate caps are set up with limits on how much the rate of interest can increase during the loan tenure. Along with that, there are payment caps that states regarding the maximum possible change in monthly mortgage payments.