Mortgages come in many varieties. There are fixed rate loans and adjustable rate loans. A fixed rate loan will hav the same payment for the life of the loan. An adjustable rate loan will vary during the life of the loan.
The terminology differs for fixed rate and adjustable rate mortgages. A fixed-rate 30 year loan means that the loan will be paid off over 30 years. A 1 year adjustable rate mortgage means that rate will be fixed for one year and will become adjustable after that. Usually adjustable rate mortgages are paid out over 30 years.
The longer that the initial rate remains unchanged, the more costly, overall, the interest rate will be. When you are looking at adjustable rate loans there are six factors to evaluate.
The first factor to look at is the length of the introductory rate. This is how long the rate will remain fixed. If you intend to sell your home in a short period of time, a short introductory rate can save you money. If you sell before the higher rates kick in this can be a way to save a substantial amount of money.
The next factor is how often the rate will be adjusted. Usually rates are adjusted annually. After you know how often the rate might change, you need to know how much it can change. Adjustable rate mortgages have rate caps. During any given adjustment period, the maximum amount the rate can change is determined by this cap.
The other factor that determines how much the rate will change is the what index the rate is tied to. There are a variety of indexes and each has its own characteristics. Generally, indexes based on averages will change less than indexes based on spot prices.
The margin is how much is tacked on to the index. For example a 2.75% margin on a treasury bill index means that your rate will be based on the treasury bill interest rate plus 2.75%. Usually loans that have longer fixed rate period have higher margins. A shorter fixed rate period will mean lower margins.
Once you’ve examined all of those items, it’s time to look at the life-of-the-loan cap. This is the maximum rate that you can be charged. This is your insurance that the rate will never become higher than you ever expected.
A good lender will be able to go over all the options with you. Before you talk to a lender take some time to think about how long you intend to live in your home and whether you think your income will go up or down over that time.
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