Decoding Mortgages: What Options Do You Have?
Do you get that sick anxious feeling in the pit of your stomach whenever your friends or family bring up home buying? Do you feel totally overwhelmed trying to sort through all the financial lingo? You’re not alone! Home buying is one of the largest purchases most people make, and it can be complicated. But don’t worry – we are here to break it down and decode some of those confusing terms.
Mortgages come in two varieties: Fixed Rate and Adjustable Rate. If you aren’t already familiar, fixed rate mortgages carry the same interest rate for the entire life of the loan. Adjustable rate mortgages will vary over time depending on the market. Most adjustable rate mortgages will be fixed for a period of time, and then change after a predetermined amount of time. You might have seen ARM 5/1 on bank window signs. ARM stands for Adjustable Rate Mortgage, the 5 is the number of years the mortgage rate will remain the same and the 1 stands for how frequently the rate will change thereafter (in this case, once per year).
Have you ever been told to avoid an adjustable rate mortgage at all costs? While it’s true that they carry more risk, there are situations where they can be a good option. ARMs will often offer a lower interest rate for the initial period than a comparable fixed rate mortgage. If you are buying a property that you only plan to own for 5 years or 10 years, then it might make sense to choose a 5/1 ARM or 10/1 ARM respectively. If you sell the property before the adjustable rate kicks in, then it really doesn’t affect you financially.
If your plans change and you don’t sell the property as expected, there is always the option to refinance with a new ARM or switch to a fixed rate mortgage, but refinancing carries the risk that interest rates will be higher at that time and you will end up paying more in interest, and there are usually fees associated with refinancing.
Another buzz word in the world of home buying is PMI. PMI stands for Private Mortgage Insurance. If you want to buy a property with less than a 20% down payment, banks will require that you pay for PMI until you have reached 20% equity in your home. This insurance allows the lender to recuperate their funds if you were to default on your payments. Once you reach 20% in equity, you can ask your lender to drop the PMI payments from your bill. You can pay PMI as one lump sum or over time as part of your mortgage payment. Different lenders will have different plans, so be sure to ask about this when you are loan shopping.
Keep your eyes peeled for our upcoming posts as we dive deeper into the exciting world of mortgages.