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While your credit score will play a role what your mortgage interest rate will be, there are also various types of loans that can increase or lower your monthly mortgage payment. In general, there are two specific loan types, adjustable rate loans, known as an ARM and fixed rate. However, within these two categories, there are various options you should be aware of before shopping for a mortgage.
Fixed Rate Loans
The fixed rate loan is exactly what it sounds like. This means your interest rate will remain stable throughout the life of your loan. Keep in mind, this does not mean your payment will remain the same — if your property taxes or insurance premiums increase and are part of your mortgage payment, the monthly payment will increase.
There are four categories of fixed rate loans that are available to borrowers. The shorter the term of the loan, the lower the interest rate. However, the shorter the term of the loan, the higher your monthly payment will be. The four categories are 10 years, 15 years, 20 years, and the most popular, the 30-year fixed rate mortgage.
Fixed rate mortgages can be as short as 10 years and as long as 30 years. Assuming you were able to secure a $100,000 30-year mortgage at a fixed rate of 3.92 percent, your total mortgage payments would be $172,000 over the life of the loan. If you were to secure a 20 year at a fixed rate of 3.5 percent, you would pay approximately $139,190 over the life of the loan. As you can see, a small decrease in rate, and decrease in time can make a significant difference.
Adjustable Rate Mortgages
If you are considering an adjustable rate mortgage, your lender may offer you different options. The most common types of ARMs are 3/1 ARMs, 7/1 ARMs and 10/1 ARMs. What this means is the first number (3, 7 and 10) means your rate will be fixed over that number of years. The second number (1) means your rate will change every year after the fixed rate period ends.
ARMs typically have what is known as a “cap” which means the amount your loan can increase cannot increase more than a specific amount. The caps may be defined as how much the monthly payment can increase over the life of your loan, over how much the rate can rise over the life of your loan, or how much the rate can increase from year to year. Before agreeing to accept an ARM, make sure you have a full understanding of the terms. It is also worth noting that many ARMs also have prepayment penalties associated with them. This means you may pay a fee to the lender if you sell your home, or you decide to refinance your mortgage.
Deciding whether a fixed rate or an adjustable rate mortgage is the right choice for you can be challenging. Some borrowers may opt for an adjustable rate, so they can meet other criteria such as debt to income ratios. Your real estate agent, and your mortgage lender can help you determine which loan is right for your needs based on the value of your home, how long you plan to own the home, and your current financial status.