| |
Rate Type
|
Interest Rate
|
Monthly
Payment
|
Equity Building
(through loan payments)
|
| 30 Year Fixed-Rate |
Fixed Rate
|
Average
|
Average
|
Average Equity Building
|
| 15 Year Fixed-Rate |
Fixed Rate
|
Lower
|
Higher
|
Accelerated Equity Building
|
| ARM |
Adjustable
|
Lower
|
Lower for initial
fixed period,
then varies
|
Average Equity Building
|
| Interest Only ARM |
Adjustable
|
Lower
|
Significantly lower
for initial fixed period, then varies
|
No Equity Building During Interest
Only Period
|
Traditional fixed-rate mortgages require that each month you pay back some of the money borrowed (the principal) plus interest on the money. The interest rate will not change throughout the life of the loan. The principal you owe on your mortgage decreases over the term of the loan. Payments are based on set loan terms, such as a 15-, 30-, or 40-year payment schedule. Generally, the shorter the term of a loan, the lower the interest rate that would apply. The most popular mortgage terms are 30 and 15 years.
With the traditional 30-year fixed-rate mortgage, your monthly payments are lower than they would be on a shorter-term loan. If you can afford higher payments, a 15-year fixed-rate loan accelerates principal repayment. Plus, you will save considerably on interest expense as compared to a 30-year loan.
Advantages of a Fixed-Rate Mortgage 
- Principal and interest payments are steady and predictable, regardless of how interest rates change in the marketplace.
- As the principal and interest portion of your payment does not change, budgeting and financial planning are made easier.
Disadvantages of a Fixed-Rate Mortgage
- Initial principal and interest payments are higher than those of adjustable-rate mortgages.
- To benefit from an interest rate decrease, you would have to refinance and incur the costs of that refinance. This could be problematic if property values are falling.
Borrowers likely to choose a Fixed-Rate Mortgage
- Persons more comfortable with the safety and security of steady and predictable principal and interest payments that remain the same if interest rates rise. (Note that if the monthly payment for any mortgage loan includes escrow amounts for taxes and insurance, your payment could change over time due to changes in property taxes, insurance, community association, or condo fees.)
- Persons planning to keep their home (and mortgage) for longer terms.
- Persons who believe that future interest rates are likely to be higher than the current rate.
An Adjustable-Rate Mortgage is generally referred to as an ARM loan. The interest rate and monthly payment on an ARM is subject to change over the term of the loan. These changes are often set to occur annually, but could be as seldom as every 3-5 years depending on the terms of your loan. Some ARM products combine features of a fixed-rate loan with those of an ARM loan. The interest rate is fixed for a set initial period. For example in a 5/1 ARM, the rate is fixed for 5 years and then can vary each year thereafter based on a specific interest rate index, plus an additional amount (margin) until the loan is paid off. The rate changes during the life of the loan are tied to an index rate that is established at the time of application, such as the rate for Treasury securities. Interest rates can go up on these mortgages, and depending on the terms of the loan, may also go down. There are usually limits (caps) placed on the amount that rates can change.
There are 2 types of caps. Periodic caps that limit the interest rate increase/decrease from one adjustment period to the next, and lifetime caps that limit the interest rate increase/decrease over the life of the loan. All dwelling-secured consumer ARM loans have a lifetime cap. Some loans also have a rate floor, being the lowest rate that can apply at any time. More information concerning ARM loans can be found in the booklet titled “Consumer Handbook on Adjustable Rate Mortgages”. This booklet is provided at the time you apply for an ARM loan; however, if interested, you may request a copy at any time.
Advantages of an Adjustable-Rate Mortgage
- Lower initial principal and interest payments.
- If rates drop, payments may become lower without refinancing.
Disadvantage of an Adjustable-Rate Mortgage
- Exposure to the risk of possibly significant payment increases if interest rates increase.
Borrowers likely to choose an Adjustable-Rate Mortgage
- Persons who are confident that they can continue to make payments even if principal and interest amounts increase significantly.
- Persons who believe that rates will remain low or even decrease and wish to easily take advantage of lower principal and interest payments.
While nontraditional mortgage loans provide flexibility for consumers, consumers may enter into these transactions without fully understanding the product terms. In addition to apprising consumers of the benefits of nontraditional mortgage products, it is our policy to take appropriate steps to alert consumers to the risks of these products, including the likelihood of increased future payment obligations.
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Interest-Only Mortgages
An interest-only mortgage allows you to pay only the interest on the money you borrowed for a predetermined initial period. This is known as the “interest-only period” (for example, the first 5 years of the loan). If you only pay the amount of interest that is due, once the interest-only periods ends:
- You will still owe the original amount you borrowed.
- Your monthly payment will increase – even if interest rates stay the same – because you must pay back the principal as well as interest.
Advantage of an Interest-Only Mortgage
- Relatively low payments for a specified period of time.
Disadvantages of an Interest-Only Mortgage
- During the interest-only period, payments that are made do not reduce the principal amount owed on the loan.
- After the interest-only period, your monthly payment will increase, even if interest rates stay the same.
- Payment shock – your monthly payment may increase by a large amount once the interest-only period expires.
- Home equity will be built at a slower pace than with traditional fully amortizing mortgage loans.
Borrowers likely to choose an Interest-Only Mortgage
- Buyers who intend to own a home for a short time or who can handle high payments in the future (including, for instance, those whose incomes are expected to increase considerably by the time the monthly payments increase).
- Persons with sizable equity in their home and will use the money that would go toward principal payments for other investments.
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