Simply put, mortgage rates are the interest generated from your mortgage and are usually determined by your lender. They are two types of mortgage rates, the fixed mortgage rate and the variable mortgage rate. It is pretty standard for mortgage rates to fluctuate (rise or fall) as can be witnessed in today’s markets.
To further break it down, we already know what a mortgage is, if you don’t, a mortgage is a loan which is specially made to finance a home. The mortgage consists of various components like taxes, collateral, principal, interest, and insurance.
In this context, the collateral is the house itself which is why if you don’t pay out your mortgage (defaults), the house is foreclosed. The principal is the amount given to you for the loan, the tax, and insurance coverage for a mortgage is dependent on the location of the home. Now the interest on the mortgage is the mortgage rate which is what we are going to discuss in this article.
Now to determine the rate of a mortgage, there are some things to be considered because of the risk involved in the business. There’s guarantee the loanee will not default so before a mortgage is given, the risk factors like credit score, etc. are considered and the higher the risk, the higher the mortgage rate.
Basically, this is done to protect the loaner from losing the investment made. If the mortgage seeker has a high credit score, the mortgage rate will reduce and vice versa.
Fixed Mortgage Rates
A fixed mortgage rate as the name implies is a type of loan where the interest rate remains constant throughout the loan term. In this type of loan, the loan duration also remains constant. This can be beneficial to the mortgage seeker because it allows you the opportunity to plan your budget to fit the fixed cost and within the given timeframe.
The fixed mortgage has some features which are used to calculate the monthly repayments; these features include; the compounding frequency, the interest rate, and duration of the loan.
This type of mortgage is being used by the United States Federal Housing Administration (FHA). It is the most classic form of mortgage in the U.S with 15-year and 30-year mortgages as the most common terms used.
In other countries though, fixed mortgage is rarely practiced with most preferring other forms of mortgages.
A variable mortgage, on the other hand, comes with interest rate which periodically changes based on an index. This index highlights the cost of borrowing on the credit market. The loan term changes due to links to the market or might just change at the lender’s discretion.
This type of mortgage is mostly practiced outside the U.S, in the U.S, the adjustable mortgage rate is used instead, and the government regulates it. This mortgage option allows borrowers to reduce the initial payments if they are willing to take the risk that might arise from the interest rate changes.
Features of the adjustable rate mortgages include;
- The initial interest rate which is the first interest rate on the mortgage
- The adjustment period which is the time when the interest rate and duration of the loan remain unchanged.
- Interest rate caps which are the limits on the interest rate or monthly payments. This changes when the adjustment period is over.
- Conversions which is the agreement that can allow the borrower to convert the adjustable rate mortgage to a fixed rate mortgage.
- Then, the index rate which is used to calculate the interest rate on the mortgage. The most common is the 1-3 or 5-year Treasury securities.
- The margin which is the percentage point used to calculate the adjustable rate mortgage (ARM) interest rate.
- Initial discounts which are offered in the first year of the loan to aid borrowers to reduce the interest rate.
- Prepayment is a negotiable clause in the agreement that will require the borrower to pay penalty if the loan is repaid earlier than the set date.
- And finally, Negative amortization which occurs when there is an increase in the balance of a loan. This is usually the result when the payments fail to cover the whole interest.
Fixed or Adjustable Mortgage Rates
Determining the right mortgage to choose leaves you with a lot to consider. You’d need to take into consideration personal factors and take a serious reality check of the prevailing economic state of the market.
Remember that the interest rates experience lots of rise and fall which is normal in comparison with the economy. So you need to consider the following carefully;
- How long will you live in the home?
- How much can you really afford in today’s mortgage market?
- If there’s a rise in interest rate, can you still afford the ARM?
- What is the current market trend in terms of interest rates and how will this trend change in the future?
In a situation where the interest rates are on a steady rise, fixed rate mortgage (FRM) is your best bet. But in a case where low payments are your target or if you know you won’t live in the property for a long time adjustable rate mortgage (ARM) is perfect for you.
Finally, you need to carefully study and understand the market before choosing which option to go with.
To check today’s mortgage rates click here