Choosing A Mortgage - Fixed Or Adjustable Rate
1. Fixed Rate Mortgage (FRM)
2. Adjustable Rate Mortgage (ARM)
Fixed rate mortgages are mortgage loans with a fixed interest rate and term. The term, or life of the loan, is normally 15 or 30 years. The interest rate is applied to the amount of the loan, or principal. Since the rate is fixed, it never changes during the entire term of the loan.
ARM's, Adjustable rate mortgages, change in association with various changes in the US prime rate, treasury bills, CD's or the Cost of funds index. This means that the monthly payment can change as other parts of the economy change. Despite the variances of the economy, ARM's do have limits, which are usually 2-3 percentage points a year capped at 6 -8 percent over the life of the loan.
Conditions in the lending industry change as the prime rates and financial markets that they rely on change. Thus, it is vital to consider aforementioned changes and how they would change your ability to repay the loan over its lifetime. You can do this by devising three financial scenarios and how they would affect you during the life of the loan before visiting a mortgage company to actually apply for the loan. By doing this, you will be able to gage if you should really apply for a particular loan amount. This is a very important step to take when considering a loan. For the following examples, we will not consider winning the lottery as a viable financial scenario.
There are three scenarios. The average scenario consists of expected monthly income as well as the average of the expected monthly expenses. The less than average scenario consists of 20% lower than the aforementioned expected monthly income as well as 10% higher estimated average monthly expenses, on top of cost of living increasing of 4% each year. The worst case scenario consists of six months worth of unemployment without any income as well as cost of living adjustments of 5% on top of anticipated expenses each year.
The scenarios that you have researched will allow you to choose a home that you really can afford. When going to a lender to actually apply, you can show an understanding of the various risks of an ARM as well as how much of an increase in a monthly mortgage payment you can withstand. By paying your bills in a timely manner and establishing great credit, you can show a lender that you are not a risk, but a good customer.