As a homebuyer, you need to understand not all homes are the same. And knowing what kind of loan is most suitable for your situation prepares you for reaching out to lenders and landing the best mortgage loan. So, what loan options do you have? To make it clear, a loan option always contains three things: loan term, interest rate type, and loan type.
Under the loan term, there is one for 15 years and the other one for 30 years. Why is loan term important? The loan term affects your interest rate, your monthly principal and interest payment, and how much you will be required to pay to clear the loan. Note, the longer the loan term, the more interest you’ll be required to pay.
For the loan type, mortgage loans are categorized based on the size of the loan and whether they are government backed or not. Under this, we have conventional loans, FHA loans, and Special program loans. Each loan type is designed for different situations and only a single loan type will fit suit your situation.
Moving on to the interest rate type, we have the fixed-rate loans and the adjustable-rate mortgages. Let’s have a deeper dive on this.
- Fixed-rate Loans.
Like the name suggests, a fixed-rate loan charges a fixed or set rate of interest that remains constant throughout the life of the loan. While the principal and interest paid each month is different with every month, the total payments remain untouched, easing budgeting for homeowners.
One big advantage that fixed-rate mortgage loan borrowers enjoy is the protection from sudden and potentially significant surge in monthly mortgage payments once interest rates rise. Additionally, fixed-rate loans are straightforward thus easy to understand and have small variances between lenders. On the other side of the coin, qualifying for fixed-rate loans when interest rates are high is very challenging since the payments are less affordable.
Moreover, while the interest rate may be fixed, the total amount you’ll be required to pay is dependent on the loan term. Shorter-term loans come with lower interest rates and higher monthly payments so as to repay the principal in a shorter period, and vice versa.
- Adjustable-rate mortgage loans.
Adjustable-rate mortgages (ARM) on the other hand, come with variable interest rates. Their initial rate is set below the market rate on a comparable fixed-rate loan and remains unchanged for a specified period, after which the rate rises with time at a pre-arranged frequency. If held long enough, the ARM rate will surpass the going rate for fixed-rate mortgages. The fixed-rate period for ARMs varies significantly anywhere in between one month and 10 years. After the initial term, ARM resets. This means it acquires a new interest rate based on the current market rates, which it maintains until the next reset.
One big advantage of adjustable-rate loans is that they are less costly compared to fixed-rate loans, at least for the first three, five, or even seven years. After this period, the cost of ARMs is likely to rise based on the current market rates and not the initial below-market rate. However, since the rates adjust based on the current market rates, they necessarily don’t rise. They may dip lower depending on the market rates at the time of reset.
Adjustable-rate loans are also preferred by many since their low initial payments often facilitate the borrower to qualify for a larger loan. Additionally, in the event of a falling-interest-rate environment, borrowers enjoy lower interest rates, which translate to lower payments, and doesn’t necessarily need to refinance the mortgage loan.
On the other hand, ARMs pose significant downsides. ARM borrowers’ monthly payments may shift frequently over the loan life. Additionally, if you borrow a large loan, you could be in trouble when interest rates surge. Some ARMs are designed in a way that interest rates can nearly or even double in a period of a few years. You should always be careful when going for this type of mortgages.
Conclusively, when choosing a suitable mortgage, always consider a wide range of personal factors including your financial status and align them with the reality of a dynamic marketplace.
Work cited.
https://www.investopedia.com/mortgage/mortgage-rates/fixed-versus-adjustable-rate/.
