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Fixed rate mortgages With a fixed rate mortgage, the interest rate and monthly payments stay the same for the life of the loan. A 30-year term is the most common, although if you want to build equity more quickly, you might opt for a 15- or 20-year term, which usually carries a lower interest rate. For homebuyers seeking the lowest possible monthly payment, 40-year terms are available with a higher interest rate. Adjustable rate mortgages (ARMs) With an adjustable rate mortgage (ARM), the interest rate changes periodically, and payments may go up or down accordingly. Adjustment periods generally occur at intervals of one, three or five years. All ARMs are tied to an index, which is an independently published rate (such as those set by the Federal Reserve) that changes regularly to reflect economic conditions. ARMs offer a lower initial rate than fixed rate mortgages, and if interest rates remain steady or decrease, they may be less expensive over time. However, if interest rates increase, you’ll be faced with higher monthly payments in the future. Hybrid mortgages are often referred to as 3/1 or 5/1, and so on. The first number is the length of the fixed term -- usually three, five, seven or ten years. The second is the adjustment interval that applies when the fixed term is over. So with a 7/1 hybrid, you pay a fixed rate of interest for seven years; after that, the interest rate will change annually. Interest-only and balloon mortgages Unlike an amortized mortgage where you pay a combination of interest and principal each month, with an interest-only mortgage you pay only interest for a fixed period -- usually from five to 10 years. This means the principal never goes down, and after this period has elapsed you have to either pay the entire principal off or start paying down the principal, which results in much higher monthly payments. Balloon mortgages also offer low regular payments for a number of years (often just slightly below what you’d pay for a 30-year fixed rate mortgage). After this fixed period, the principal must be repaid as a lump sum, which generally means refinancing. Because very little of the principal has been paid down, once again, your payments will increase. These loans can be helpful temporarily but they can cause serious financial strain when the principal comes due. |
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