The Different Types Of Mortgages In Texas: Which Is The Right One?
A potential homeowner who approaches a lending institution for a mortgage loan should be knowledgeable on the different kinds of mortgages that exist. Furthermore, they have to understand the advantages and disadvantages of each type of mortgage facility. This article takes a deep dive into the following mortgages: fixed rate, adjustable rate, 2-step, 3/3 and 3/1 adjustable rate, 10/1 adjustable rate, 5/25 mortgages, 5/5 and 5/1 adjustable rate and balloon mortgages.
Fixed Rate Mortgages
As the name indicates, a fixed rate mortgage has the same interest rate throughout the entire loan period. These mortgages are quite popular accounting for 3 out of every 4 home loans taken. The period of the loan agreement can be 10, 15 or 30 years. The 30-year mortgage is a favorite of many people. Though the 30-year mortgage is the preferred choice for a lot of people, it builds up equity very slowly. The 15-year option provides the fastest equity accumulation.
The major edge of the fixed rate mortgage is that the homeowner is certain on the principal and interest payments throughout the term of the loan. Certainty on payments allows the homeowner to plan their finances with ease as they are sure that the repayment amount is constant.
Due to their predictability, fixed rate mortgages are favored by homeowners. The interest rate is fixed, the percentage agreed upon on commencement of the loan term does not vary. Payments are constant hence the homeowner knows the exact amount to pay each month. This provides for better insight during budgeting. A borrower who takes up a mortgage during a high-interest rate environment can refinance the mortgage when the rates move lower. However, for refinancing to occur closing costs have to be paid.
The table below provides a comparison of the current interest and the corresponding monthly installments for the different types of home loans.
One Year Adjustable Rate Mortgages
These have adjustable rates. This means that the interest rate for an ARM (adjustable rate mortgage) changes based on a predetermined periodic schedule after the fixed rate period at the beginning of the loan elapses. It is a risky alternative as the payments fluctuate significantly from one period to the next. To compensate for the excessive risk taken by the homeowner, a lower interest rate than that of the 30-year fixed rate is applied. Simply put when one borrows using a one year ARM they will have acquired a 30-year loan where the interest rate is reset each year on the loan commencement anniversary date.
Using the one-year adjustable-rate option allows the homeowner to be approved for a higher loan limit, therefore, affording them the opportunity to acquire a higher value house. Homeowners with substantial mortgages can use ARMs and then refinance each year. Lower rates provided under the option will enable them to purchase more valuable homes. Also, they make lower monthly repayments as long as rates remain low.
For the 10/1 ARM, the interest rate for the first ten years of the mortgage is fixed. Once the ten years are over, the rate changes after every year for the remainder of the loan period. The life of the loan is thirty years, so the customer will have the stability of a 30-year fixed rate mortgage for the first ten years at a lower cost than that of a fixed mortgage loan with the same tenure. However, the adjustable-rate mortgage is not the top option for individuals keen on owning the same house for more than 10 years unless they are accelerating loan repayment through extra payments with the intention to clear their loan in advance.
A 2-step mortgage is an ARM that has a constant rate for a fraction of the loan and another rate for the remaining section. The interest rates are aligned or changed with respect to the prevailing market rates. The customer might be accorded the chance to choose between a fixed interest rate and a variable rate at the variation day.
Borrowers who choose a two-step mortgage carry the risk that the rate on their mortgage loan will be adjusted upward once the fixed-interest rate stretch is over. Customers who use two-step mortgages usually have intentions of refinancing in the future or are likely to move out of the house before the loan period comes to an end.
5/5 And 5/1 ARMs
5/5 and the 5/1 ARMs are variations of adjustable rate mortgages where the interest rate and the monthly installment remain constant for five years. The interest rate is usually adjusted at the beginning of year six. Henceforth, for the 5/1 ARM, the interest rate is adjusted after every year while for the 5/5 the change is effected after every 5 years. These ARMs work best for homeowners who intend to stay in the home for more than five years and are open to fluctuations in payments later on.
This mortgage is also referred to as a “30 due in 5” where the interest rate and the monthly installment remain constant for a period of five years. After the end of the five years, the interest rate is changed to correspond to the prevailing current rate. This means that over the remaining mortgage tenure the payment will not vary. This is an excellent option if the customer is comfortable with a single variation of the payment over the mortgage period.
3/3 And 3/1 ARMs
3/3 and 3/1 ARMs are housing loans where the interest rate and the monthly payment remain constant for 3 years. Changes to the interest rate only occur after the end of the third year. At the start of year 4, the interest rate is changed, for 3/3 ARM the change is after every three years. On the other hand, the 3/1 ARM’s rate changes each year. If a homeowner is considering an adjustable rate after three years this type of mortgage is a perfect solution.
They are similar to a fixed-rate mortgage on the way they work and last for a short duration. Usually, monthly installments are significantly lower due to the large lump-sum payment at the end of the mortgage. Basically, only interest is being paid on a monthly basis hence the lower payments. Balloon mortgages are highly suitable for responsible customers who plan to sell their home prior to the expected date of the balloon payment. This is a risky option. If homeowners are unable to meet the balloon payment on the due date they might be necessitated to refinance the balloon payment from the initial lender of the mortgage.