Home Loans: Fixed Mortgages vs. ARMs

As a potential home buyer it is always important to understand the different types of home loans. Learn about the difference between fixed versus adjustable-rate mortgages with help from a financial adviser with this free video on real estate.

Video Transcript

This is Morgan. He's married. He just had a new baby and he's ready to buy his first home. This is "A Home of Your Own." As a potential home buyer, I wanted to understand the different home loan types. So I paid a visit to my financial adviser. He explained that there are several different loan types, but the two popular loan types are fixed-rate and adjustable-rate mortgages, or ARMs. The main different between the two is that fixed-rate loans have the same interest rate for the life of the loan. You know exactly what you will be paying toward principal and interest every month for the entire length of the loan, which makes it easier to budget. My financial adviser said that if I plan on living in the home for a long time, or prefer payment stability, a fixed-rate mortgage might make sense. An adjustable-rate mortgage is subject to change periodically based on changes to a financial index. How much and how often your monthly mortgage payment can change are two of the important items you want to understand before making a loan choice. Most lenders today offer a hybrid ARM, also known as a fixed-period ARM, which is an adjustable rate mortgage that features an initial fixed interest rate period, typically of five, seven or ten years. And after the fixed-rate period expires, the interest rate becomes adjustable for the remainder of the loan term. Fixed-period ARMs are often named by the length of time the interest rate remains fixed. So, for example, a five-one ARM would have a fixed rate for first five years, then can adjust each year for the remaining term of the loan. The rate on this kind of loan tends to be lower during the introductory period, which can mean a lower starting monthly payment. However, when the introductory period ends, your rate will go up or down depending on the prevailing market rate. Most ARMs include caps in each adjustment period and a lifetime cap, above which your rate will never rise. So, if I'm considering an ARM, it's especially important that I look at the lifetime cap to see how much I would be paying every month if interest rates went high enough to trigger the cap. That figure represents the highest mortgage payment I could ever be charged for my ARM. For example, a two percent increase in the interest rate per adjustment period and six percent from the starting interest rate would both result in a large monthly payment increase. So, I have to ask for details and plan accordingly. It's also important to know my lock period. That refers to the amount of time, prior to closing on the home, when you can lock in to secure an interest rate for a loan. A rate lock is the lender's promise to you that the terms of your loan won't change during the time period when your mortgage application is being processed. Lock periods typically range from thirty days to more than ninety days. There might be a fee associated with locking in your rate, either in terms of points or a slightly higher interest rate. Whether or not to lock in your rate is an important consideration when it looks like interest rates may go up. Since interest rates fluctuate frequently, things can change between the day you apply for your loan and the day you close your loan.

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