Mortgage

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Overview

In simple terms, a mortgage is a loan in which your house functions as the collateral. The bank or mortgage lender loans you a large chunk of money (typically 80 percent of the price of the home), which you must pay back -- with interest -- over a set period of time. If you fail to pay back the loan, the lender can take your home through a legal process known as foreclosure.

Mortgage Types

Fixed Versus Adjustable Rate

In general, fixed-rate mortgages are for borrowers who expect to have their mortgage longer than 12 years. Beyond that, the cumulative effect of rate increases will probably outweigh the benefits of low rates in the early years. Taking an adjustable solely because of the lower initial payment is risky because of the potential for sizeable payment increases. It should be avoided -- unless the borrower has solid reasons for expecting significant increases in future income.

30-Year Fixed-Rate

The interest rate on the 30-year FRM on August 21 was 3.625% and the payment $1847. The 30-year FRM is the default choice, meaning that it is the type of mortgage selected if there is no compelling reason to select another type, or if the borrower doesn’t care to invest any time in considering alternatives. Even if it is not the best choice, it won’t be a terrible choice.

15-Year Fixed-Rate

The interest rate was 2.875% and the payment $2773. Comparing the 15-year FRM with the 30-year FRM, the decision process is simple and straightforward. The payment on the 15 is 50% higher but the borrower becomes debt-free in half the time. In my book, if you can afford the payment on the 15, you take it.

5/1 ARM

The initial rate is 2.50% and the payment $1600. All ARMs have 30-year terms, the prefix numbers 5/1 indicate that the initial rate holds for 5 years, after which it adjusts every year. The rate on the 5/1 thus adjusts in months 61, 73, 84, and so on.

How to Choose

Take the 5/1 ARM if

  1. You are 80% sure you won’t have the mortgage more than 5 years, and
  2. You are 98% sure you won’t have the mortgage more than 8 years, and
  3. If necessary, you will be able to manage a 24% increase in payment in month 61, a 29% increase in month 73, and a 9 % increase in month 84.

7/1 ARM

The initial rate is 2.625% and the payment $1627. The decision rule is that the 7/1 ARM should be selected if:

  1. The 5/1 ARM is not a good choice, and
  2. You are 80% sure you won’t have the mortgage more than 7 years, and
  3. You are 98% sure you won’t have the mortgage more than 10 years, and
  4. If necessary, you will be able to manage a 59% increase in payment in month 85.

10/1 ARM

The initial rate is 3.0% and the payment $1707. decision rule is that the 10/1 ARM should be selected if:

  1. The 5/1 and 7/1 ARMs are not good choices, and
  2. You are 80% sure you won’t have the mortgage more than 10 years, and
  3. You are 98% sure you won’t have the mortgage more than 12 years, and
  4. If necessary, you will be able to manage a 51% increase in payment in month 121


References

Choose Best Type of Mortgage


Experiences shared by trusted users

Detailed comparisons among multiple mortgage providers, in Apr, 2015

Refinances with rate numbers and tip to get approval, in Nov, 2016