Mortgage Basics: Fixed Rate and Adjustable Rate Mortgages

A mortgage is defined as a long-term loan for the purchase of property and the buildings on the property. Mortgages can be obtained from banks, mortgage companies, and credit unions; sometimes a seller will also be willing to finance the home he/she is selling. There are many kinds of mortgage options a potential home-buyer has. Each kind of mortgage has specific characteristics which may determine the appropriateness for the borrower.

Fixed Interest Rate Mortgages

• Available for 10, 15, or 30 years
• One portion of the monthly payment goes toward interest due
• Another portion of the monthly payment goes toward the reduction of the principal
• Interest rates remain the same for the entire term of the loan
• Monthly payments remain the same for the entire length of the loan
• Note: payments may increase if property taxes are included in the loan and property taxes increase during a certain year.

Appropriate for borrowers who:

• want to remain at the home for more than 10 years
• like certainty of payments
• are skeptical about future interest rates
• want the stability of payments for budgeting purposes

Adjustable Rate Mortgages (ARM)

• Available for 10, 15, or 30 years
• “Introductory”, or initial, periods available for 1, 3, 5, or 7 years
• Introductory interest rate is applied for the initial period and is usually lower than fixed interest rates
• Interest rates fluctuate (adjust) after introductory time and adjustments are based on a specific index rate
• Adjustment Periods: predetermined periods (usually every year, 3 years, or 5 years) when the rates and payments may change
• Adjustment Caps: limits on how much the interest rate can fluctuate at each adjustment period
• Lifetime Caps: limits on how much the rate can change over the life of the loan

Appropriate for borrowers who:

• may not qualify for a fixed rate loan
• expect an increase in income in future years
• can accept later changes
• are willing to take risks for future interest rates

Types of ARMs

10/1 ARM

• Monthly payment and interest rates are the same for 10 years; in the 11th year,
• Interest rate adjusts every year for the remainder of the loan
• Appropriate for people who plan to live in property more than 10 years and like initial payment stability but can accept later change or plan to move in 10 yeas but want loan to remain in force in case plans change

7/23

• Monthly payment and interest rates stay the same for 7 years; in the 8th year, interest rate adjusts to reflect current interest rates with payments remaining the same for the final 23 years.
• Appropriate for people who plan to live in property more than 10 years and can tolerate one payment adjustment or plan to move in 7 years but want loan to remain in force in case plans change

7/1 ARM

• Monthly payment and interest rates stay the same for 7 years; after 7th year the interest rate adjusts every year with payments changing every year for the remainder of loan
• Appropriate for people who plan to live in property more than 7 years and like initial payment stability but can accept later changes or plan to move in 7 years but want loan to remain in force in case plans change

7 Year Balloon ARM

• Monthly payments are computed using a 30 year term; monthly payment and interest rates stay the same for 7 years; at end of 7th year, the loan is due in full (balloon payment)
• Appropriate for people who plan to live in property more than 7 years and are willing to refinance at prevailing market rates or who plan to move in 7 years and like payment stability

5 Year Balloon ARM

• Monthly payments are computed using a 30 year term; monthly payment and interest rates stay the same for 5 years; at end of 5th year, the loan is due in full (balloon payment)
• Appropriate for people who plan to live in property more than 5 years and are willing to refinance at prevailing market rats or plan to move in 5 years and like payment stability

5/1 ARM

• Monthly payment and interest rates stay the same for 5 years; after the 5th year the interest rate adjusts every year with payments changing every year for the remainder of the loan.
• Appropriate for people who plan to live in property more than 5 years and like initial payment stability but can accept later changes or plan to move in 5 years and want loan to remain in force in case plans change

5/5 ARM

• Monthly payment and interest rates stay the same for 5 years; after the 5th year the interest rate adjusts every 5 years with payments changing every 5 years for the remainder of the loan
• Appropriate for people who plan to live in property more than 5 years and like initial payment stability but can accept later changes or plan to move in 5 years and want loan to remain in force in case plans change

5/25 ARM

• Monthly payment and interest rates stay the same for 5 years; in the 6th year, interest rate adjusts to reflect current interest rates with payments remaining the same for the final 25 years.
• Appropriate for people who plan to live in property more than 5 years and can tolerate one payment adjustment or plan to move in 5 yeas and want loan to remain I force in case plans change

1/1 ARM

• Interest rate adjusts every year; thus monthly payment may change every year for entire length of the loan
• Appropriate for people who want to take advantage of lowest rate possible and are willing to accept change every year or cannot qualify at higher rate programs