Home Loan Information
- Receive multiple home loan offers and compare mortgage rates
Let's understand the basic types of loans.
Fixed-Rate Mortgage
This is the plain-vanilla loan that most people think of when considering a
mortgage. You will owe a certain percentage of the loan as interest to the lender.
This amount never changes, and your monthly payment will remain the same over the
life of your loan. Loans for homes are usually for 15 or 30 years.
ARM
No, not the thing hanging from your shoulder. This is an "adjustable-rate mortgage."
The interest rate changes to reflect changes in the credit market out in the great,
wide world. The first-year rate (otherwise known as the teaser rate) is generally
a couple of percentage points below the market rate. There are also upward limits
above which the interest rate isn't allowed to go -- this is called the cap. If
your teaser rate is 4%, and you have a five-point cap, then the highest that your
interest rate could go would be 9%. What's more, the amount that the interest rate
can rise each year is limited, usually to one or two percentage points per year.
The frequency at which the rate adjusts may vary; make sure you know these features.
If you're considering an ARM, think about the worst-case scenario. What if interest
rates go up, and your ARM adjusts to its maximum? What will that maximum be, and
when will it kick in? Will you be able to afford the payments? And that, folks,
is it: the two major types of loans. Now let's look at some subsets and variations.
COFI, Anyone?
One type of ARM is a COFI loan. COFI stands for "cost of funds index." This
loan doesn't have any caps, and adjusts monthly. It is, in a sense, the most adjustable
ARM of all, since it isn't fixed for a certain time. But the index to which it is
tied is in many ways the most stable index of them all: It is tied to the rate that
banks have to pay their depositors to keep their money (i.e., checking accounts,
savings accounts, certificates of deposit). It tends to be a slow-moving index.
The COFI loan has certain advantages in that you can vary the amount of your payments
as you wish (paying off more or less each month). If this suits your temperament
and your budget, inquire about it since it is often not brought up as an option.
Hybrid Loan
Just as in a candy store, why have two flavors when we can have a mix and make
three? Sure, your hands may get sticky and your tongue can turn green, but we like
freedom of choice. Typically a hybrid loan is fixed for 1, 3, 5, 7, or 10 years
and then converts to an ARM. This means you get stability for a given amount of
time, and then your fate is cast to the winds of the prevailing interest rates.
If you imagine a fixed-rate mortgage as a motorboat, and an ARM as a sailboat, then
you get to run the ship under its own engines for a time before you unfurl those
sails and hope for favorable winds.
Two-Step Loans
These loans attempt to have the best of both worlds: the stability of a fixed
loan with the lower rates of an ARM. They appear in their most common forms as 5/25
or 7/23 loans. Math buffs among you will note that the numbers straddling those
slashes add up to 30, as in a 30-year loan. This means that your interest rate will
be fixed for the first five or seven years, then the loan adjusts in one of two
ways: It will either become an ARM, adjusting annually, or a fixed-rate loan. The
beginning interest rate for these loans is generally lower than that of a standard
30-year fixed loan.
Balloon Loans
These tend to be short-term loans. You borrow money for, say, three or seven
years, and the loan is amortized as though it were a 30-year loan. At the end of
the three- or seven-year period, you owe the bank all of the remaining principal,
in one lump sum -- like a big balloon. Again, these loans tend to have lower interest
rates than the standard 30-year mortgage. If you're not planning to stay too long
in your house, you might be interested in such a loan. The reasoning goes like this:
You pay less in interest -- saving potentially thousands of dollars -- over the
course of the loan than you would with a 30-year fixed. So you're less out-of-pocket
when it comes time to sell. Keep in mind, though, that if for some reason your plans
change and you want to stay in the house, you're going to have to pay off the loan
in full -- by getting another loan, at the prevailing interest rates, and with the
attendant costs of getting that new loan. So it isn't for the faint of heart or
irresolute of mind.
Pros and Cons
To review: There are two main loan categories -- fixed- and variable-rate. What
are some of the pros and cons of these two main types?
Fixed-Rate Mortgage
Pro: You can determine exactly how much you're going to pay each month for the next
30 years. Con: You will pay a premium for this predictability. This loan will generally
cost more than an ARM. Tip: Get a fixed-rate mortgage if stability is important
to you or you're less than confident about the economy or your job security. (If
it's the latter, you ought to have a nice nest egg stashed away.)
Adjustable-Rate
Mortgage
Pro: Because the interest rates are lower for this type of loan, it's easier
to borrow more. This is often important to first-time home buyers who are already
stretching the limits of what they can afford. Con: If interest rates rise you could
be up the creek without a paddle -- if you haven't done your homework and figured
out whether you could afford the worst-case payments. Tip: Get an ARM if you're
expecting to stay in your house for less than five years.
Home Loan Information
- Receive multiple home loan offers and compare mortgage rates