Variable Vs. Fixed Rate Mortgage
A mortgage is a loan that is generally used for the purchase of a house. These loans use the house as collateral so that the bank has property that it can foreclose on if that loan is not paid. The interest rate of the loan is one of several choices that a consumer will have to make when deciding what type of mortgage to get in addition to the term of the loan and how much of a down payment to make.
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Mortgage Rate Factors
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Mortgage rates are affected by several factors. The current market rate is one of the most important because it sets the baseline for the rates for the most creditworthy customers. The rate also depends on the length of the mortgage. Your credit score and the credit score of your spouse, cosigners and co-borrowers will determine if you get the lowest rates. Shorter mortgages like 15-year terms will usually have lower rates than longer terms like a 30-year mortgage.
Fixed-Rate Mortgages
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Fixed-rate mortgages have the same interest rate over the entire term of the loan. These loans are advantageous for people who enjoy knowing that their monthly mortgage payment will always remain the same so they can budget more effectively and not be caught off guard if interest rates rise. They are the most beneficial when interest rates are low because you guarantee yourself that lower rate for the entire term of the loan. The downside to a fixed-rate mortgage is that if interest rates fall drastically, you will be stuck with the same rate.
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Variable-Rate Mortgages
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Variable-rate mortgages adjust the rate of the loan as the market rate changes. One type of variable-rate loan is known as an adjustable-rate mortgage (ARM). An ARM will have the same rate for a certain period of time and then update the interest rate of the loan after a certain number of years. For example, a 5/1 ARM will have the same fixed rate for the first 5 years and then it will adjust annually while a 3/3 ARM will have the same fixed rate for 3 years and then update the rate ever third year after that.
Caps on Variable Rate Mortgages
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Some variable-rate mortgages will have caps that limit how much the interest rate can change. A periodic rate cap limits how many percentage points the interest rate can change each time it is adjusted. A lifetime cap limits how much the interest rate can vary over the term of the loan. A payment cap limits the amount that the monthly mortgage payment can change rather than the amount the interest rate can change.
Introductory Rates
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Some banks will offer introductory rates for new mortgages. These rates can be in effect for a few months to a year or two and may be a percentage point or two below what the rate of the loan will be for the remainder of a loan. Introductory rates can be found on both fixed-rate loans and variable-rate loans. For example, a fixed-rate mortgage at 6 percent may have an introductory rate of 4 percent for the first six months. A variable-interest loan may have an introductory rate 0.5 percent below the market rate for the first two years and then switch to the market rate after that.
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