You should be familiar with each type of interest rate if you want to get a home loan. Knowing the advantages and disadvantages of each type will help you make an informed decision. This article will discuss these common types of home loans available.
1. Adjustable Rate Home LoanThe interest rate of this type of home loan is completely dependent on the standard variable rate which changes based on the situation of the market. Since market fluctuations affect this type of home loan, the rates are prone to increase and decrease from time to time.
The interest rate and monthly payments are usually low at the beginning of the loan but since the rates change from time to time, you are forced to pay them irrespective of the amount of increase. This is why most people prefer fixed rate home loans which are devoid of this unpredictability.
Because of the risk involved with adjustable rate loans, you have to pick the right type of this mortgage. The best way to manage the risk is to take a loan that has restrictions and caps. The restrictions will place limits on how much the loan can adjust.
The caps can be applied to your interest rate or your amount of monthly payment. Your loan can also include a specified number of years that must pass before the rates begin to adjust. It could be the first three or five years. These restrictions protect you from the risks associated with adjustable rate loans.
Banks offer two types of adjustable rate loans — interest-only loans and option adjustable rate mortgage. Interest-only loans usually have very low rates compared to others. With this loan, your monthly payment for the first few years goes towards interest and not the principle. After like three to five years, you start charging higher amounts to cover the principle.
Option Adjustable Rate Mortgages allows you to choose how much you want to pay every month. They start with low teaser rates which can increase to higher rates even after the first payment. Most people who take this type of loan, make only the minimum payment every month. The remaining is added to the balance of the mortgage.
2. Fixed Rate Home LoanThis type of home loan is popular. The interest rate is completely fixed so you will be able to easily predict how much money you should save every month to pay the interest rate. Market fluctuations for not affect fixed home loan rates, so they remain fixed for the entire period of the loan.
For this type of loan, a part of the principal is paid off each month. This reduces the interest payment on the remaining principal. So, more of your monthly payment goes towards the principal. In the beginning, most of the payment goes towards interest but at the end of the loan, most of it goes towards principal.
This type of home loan seems like the best deal since market fluctuations for not affect the interest rates. But if the market rates fall, you will not be able to change your interest rate so you may end up paying more than you should at that point in time. But many people still prefer fixed rate home loans because of its predictability. This is a feature that adjustable rate home loans don’t have.
The advantage of the fixed rate mortgage is that you make the same payment each month. This predictable nature for the interest rate allows you to plan your budget better. No need to worry about a future increase in payments like in adjustable rate loans.
Fixed rate mortgage also allows you to make extra payments if you want to pay off your principal quickly. This type of loan is great especially when you think that interest rates will go up in the future. This is because your rate will be not be affected.
The disadvantage is that the interest rate for fixed rate loan is higher than that of an adjustable-rate loan. That means you will pay more and even if interest rates fall in the future, you will still pay at a high rate.
Also, because the payments over the first few years mainly go toward interest, you pay off the principal at a slower rate than with an adjustable rate loan. So this type of loan is not ideal if you plan to sell your house in the near future.
It is not easy to qualify for fixed-rate loans. Banks make you pay higher closing cost like conventional loans because they don’t want to lose money if rates go up. They cannot take that risk especially if you are taking a 30-year loan. So you have to pay to cover that risk. It is better to get an adjustable-rate loan if you plan to move in the next five to 10 years.
3.Balloon Rate Home LoanIn this type of loan, a specific amount is lent to the borrower at a certain rate. The rate changes after a specified period. There are usually two payment options, the 7/22 and the 5/23. This means that you have either 5 or 7 years to pay the entire loan at a fixed rate or you can repay the loan at the new interest rate. The numbers 5 and 7 indicates the number of years the loan will have a fixed rate and the numbers 25 and 23 show the remaining period of the repayment. If you choose any of these options, you will have 30 years to repay the loan.
We have discussed the different types of interest rate for home loans. You are free to choose any option you like. Remember to consider your finances before making your choice.