Borrowing money to purchase a home is an intimidating process. There are several different types of mortgages and they have a lot of variations. However, you don’t need to become a loan expert to get a mortgage. Let’s start with the basics and look at the most common mortgages: a fixed-rate or adjustable-rate (ARM).
Both types allow for borrowing a huge chunk of money that you can repay slowly in monthly payments. Also for both your years’ payments go mostly toward repaying interest on the debt and then, as time goes on, your equity in the home grows faster. Both types also require you to demonstrate your creditworthiness by disclosing details about your debts, assets, income, credit score and credit history.
Fixed-rate mortgages have some of their own characteristics. They are predictable and tend to be safer for borrowers. They’re usually longer-term loans. 30 years is pretty standard but 10 or 15-year fixed-rate mortgages occur also. With a fixed-rate mortgage, your interest rate is locked in when you get the loan and will stay the same as long as you keep the mortgage, either until you sell, refinance or pay it off. If your mortgage is 4% at the start, it will remain 4% in 30 years. Fixed-interest-rate mortgages are best for borrowers when interest rates are on the way up and/or if you expect to stay in the home for five years or more.
On the other hand, with adjustable-rate mortgages (ARM) or variable-rate mortgages, interest rate change over time. They usually begin with a “teaser” interest rate, one that is lower than the current market rate. After a period of time set in the contract, the interest rate adjusts on a regular basis. This means your monthly payments will change. These can also be for any range of time but 30-year mortgages are most popular. Everything will be spelled out in your contract so be sure to read it before signing!
With ARMs, your rate may reset monthly or yearly but this reset time period can change throughout the contract, which is why it is important to read the fine print carefully. It may even be helpful to get help from an attorney or knowledgeable friend. The federal Consumer Financial Protection Bureau’s Handbook on Adjustable Rate Mortgages can help too. When interest rates are rising, such as now, with an ARM, your monthly payment is likely to grow over time.