There are many ways that you could structure a home loan payment but there are some that are more popular and well known than others. Overall, they fall into one of two main categories defined by the terms of the interest payment: Fixed interest rates throughout the term of the loan and adjustable rate mortgages (ARMs).
Each side has benefits and disadvantages and so it is a matter of establishing the one that is best suited to your needs as a homeowner.
Fixed Rate Mortgage Financing
Fixed rate mortgages are very popular because of the certainty that interest rates will not suddenly go up, putting the homeowners under water with extortionate payments. The United States has not had exceptionally high interest rates in a generation and yet the pain that they can cause seems so real to many borrowers.
There tend to be two popular terms of conforming (suitable for government backing) fixed rate loans, either thirty-year or fifteen-year terms. The interest rate of a fixed rate loan is fixed at the start of the loan. Even if your fixed rate loan seems like a real bargain you can be sure that there is a part of your interest that is added in to account for the risk to your lender that they are losing out on extra income from some possible future interest rate hike.
ARM Caps and Indexes
Adjustable rate mortgages tend to be slightly cheaper than fixed rates because, if interest rates go up in the future they will be able to raise your interest payments. There is usually a limit called a cap on how much the lender can increase the rates when it is time to adjust them.
For example, if you have a 3/2/6 ARM it means that you rate will stay at the initial rate for three years, then it can adjust by as much as 2% once a year but only up to a maximum of 6% above the initial interest rate.
So, the term adjustable is pretty mild and the adjustments are only on rigid terms. The amounts by which they adjust are determined by a predetermined financial index that will be named in the terms of your loan.
The sort of index will be something like the London Interbank Exchange Rate (LIBOR) or similar. Indexes like the LIBOR are used because they have a connection to the inner financial condition of the economy and tend correlate to the prime-lending rate, along with other basic factors.
Fixed Rate Vs Adjustable Rate Mortgages In Summary
Fixed rate mortgages give you the certainty of knowing your rate cannot change. However you are paying for that privilege with a little extra interest on your loan. ARMs start out at more competitive rate and adjust after a fixed period.
This should be clearly stated and controlled rigidly within the terms of the loan, with only limited periodic reviews based on fundamental market indexes. There will also be caps on the amount by which your ARM can adjust at a given time and in total. So, although the risk is real, it is limited to a narrow range of changes.
Along with other terms of your home loan fixed and adjustable rate give you choice in the market for a home loan that meets your own personal needs. Neither category is going to be onerous, as long as you have read the terms and considered the risks and consequences you should be able to find the mortgage that is best for you.