Mortgage Types: Fixed and Adjustable Rate Mortgages
Fixed and adjustable rates mortgages are the two primary types of mortgages. In fact, most loans can be categorized as either fixed or adjustable, or a combination of both.
Fixed rate mortgages
Fixed rate mortgages are the simplest to understand. Your interest rate and payment stay constant for the duration of the loan. Most fixed rate mortgages are for 30 years, although you can also get them for 15 or 20 years.
Fixed rate mortgages with shorter durations will usually have lower interest rates. Since you have less time to pay off the loan, the monthly payments will be higher, but you will end up paying less interest over the life of the loan.
Adjustable rate mortgages
Adjustable rate mortgages(ARMs), as the name implies, have an interest rate that varies over the life of the loan. The interest rate of an ARM is determined by the index to which it is tied, plus the lender's margin, which is usually two to four percentage points. ARMs can be tied to a number of indexes, the most common of which is the one-year U.S. Treasury bill.
Periodically, the index will be evaluated and the interest rate of the mortgage will be adjusted accordingly. How often the rate is adjusted is specific to each loan, but can be as often as every month. To prevent the rate from increasingly too rapidly, adjustable rate loans will limit how much the interest rate can increase in a year. In addition, there will be a cap or upper limit as to how high the rate can go.
A hybrid mortgage is one example of a loan that combines the features of both a fixed rate and adjustable rate mortgage. It starts out with an interest rate that is fixed for a number of years (typically 3, 5 or 7) and then converts to an ARM. One popular example of a hybrid loan is a 5/1 ARM. For a 5/1 ARM, the interest rate and monthly payment remains the same for the first five years of the loan. Starting the sixth year, the interest rate is adjusted every year.
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