Home loan plans fall into three simple categories: fixed-rate loans, adjustable-rate mortgages, and hybrid loans, which have features of fixed-rate loans and ARMs.
Fixed-rate mortgages have interest rates that don't change during the life of the loan. The interest rate on an adjustable-rate mortgage (ARM for short) adjusts every six to 12 months, or every month, depending on the terms of the loan. When interest rates fall, the ARM interest rate usually falls, but the opposite is true when interest rates increase.
Adjustable-rate mortgages "are tied to an index which is a measure of the lender's cost of borrowing money. As the index rises, so will the interest rate on the adjustable loan," according to Dian Hymer, author of "Buying and Selling a Home, A Complete Guide," Chronicle Books, San Francisco; 1994. Common indexes include Treasury Securities (T-Bills), Certificates of Deposit (CDs), and Libor (London inter-bank offering rate). Most metropolitan newspapers publish current ARM index rates.
The interest rate and payment adjustments may or may not be scheduled to change at the same time. For example, the interest rate on some plans changes more frequently than the monthly payment, which may result in negative amortization. "This means that the additional interest will be added to the principal balance of the loan and may accrue additional interest itself," Hymer says. If the monthly payments on an ARM are increasing, generally this is because the index is rising or it is a negative amortization ARM.
Introductory rates on ARMs are usually two or three percentage points lower than the fixed-rate. Because initial expenses will be lower with an ARM, a lender is more likely to lend you more money than with a fixed-rate loan.
Hybrid loans start with a fixed rate that's guaranteed for an established period, usually one to five years. After that period, the loan becomes an ARM.
The difference in payments and overall savings between a 15-year fixed-rate loan and a 30-year fixed-rate loan depends on the interest rate and the loan amount. Using a $100,000 loan and 7.25% interest rate as an example, monthly payments on the 15-year note would be $912.86. Monthly payments on a $100,000 loan at 7.25% fixed for 30 years would be $682.18.
The 15-year note offers the opportunity to save considerable money over the life of the loan, since the period of amortization is half that of the 30-year note. This means that the total interest paid on a 15-year note as compared to a 30-year note is significantly less. Calculating the overall savings of the 15-year note over the 30-year note depends on several individual circumstances, such as the borrower's changing income status.
Smaller monthly payments are the primary advantage of adding 10 years to the traditional 30-year mortgage, but real estate experts say the shorter-term loan usually is more beneficial for the home buyer. The drawback becomes apparent simply by calculating the cost of additional interest payments, which can total thousands for a few dollars difference in mortgage payments.
Points
Points are prepaid interest charges paid to the lender at the time of closing. One point is equal to 1 percent of the total loan amount. The more points you pay, the lower your interest rate will be.
Lenders usually charge $200 to $300 for application or processing fees. Some lenders don't charge the fee; some return it if you take the loan.
Credit reports cost $30 to $50 to obtain a copy for the lender.
Appraisals are necessary to assure the lender that the property is worth approximately the price you agreed to pay. An appraisal of an average house costs a few hundred dollars.
