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In a fixed-rate mortgage, your monthly payments will remain essentially unchanged over the term of your loan. That's why this loan is considered one of the safer ones out there. There will be no surprises later down the road if interest rates rise.
You agree upon the interest rate and monthly principal in the very beginning, and it will not change over the entire term of the mortgage. So you can see why this mortgage is considered to be an extremely stable one. It protects you from rising interest rates and makes planning for the future very easy.
There can be a down side however, to the fixed-rate mortgage. In some economies, interest rates for a fixed-rate mortgage can be considerably higher than the initial interest rate of some of the other mortgage options. As it protects you from rising interest rates, it also enables you to take advantage of falling interest rates. You do always have the option to refinance though, if the interest rates drop significantly.
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Adjustable-Rate Mortgages (ARMs)
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An adjustable-rate mortgage is almost the opposite of the fixed-rate mortgage. Your interest rate will rise and fall with the economies'. Because the initial interest rate of an adjustable-rate mortgage is usually lower than with a fixed-rate mortgage, an adjustable-rate mortgage might be best if you're buying a home when interest rates are high, or you don't plan on living in your home very long. Keep in mind though, with an ARM, you are taking the risk on the rise or fall of interest rates, not the bank.
Each lender bases their interest rates off of a specific index such as COFI, LIBOR, the T-Bill rate, or the CD index. The interest rate that you pay will be based on your lender's index PLUS a margin, which is usually two or three points.
You may be worried about interest rates sky-rocketing and you getting stuck with a much higher interest rate than you ever imagined. Well there is some protection. "Caps" will limit the amount your lender can increase your interest rate within a single year and over the entire term of your loan. So ask your lender for the specifics.
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There is a mortgage out there that offers you the best of both worlds from fixed-rate mortgage and the adjustable-rate mortgage. It's called the convertible ARM.
The convertible ARM allows you to start out with an adjustable interest rate, and then convert to a fixed-rate mortgage after a certain period of time. For instance, you could get a one-year ARM with the option to convert any time after the first through the fifth adjustment period. This mortgage allows you to take advantage of the standard lower interest rate of an ARM, and then switch to the security of the fixed-rate mortgage later. You can see why this mortgage has become very popular.
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Another type of mortgage that might be right for is the balloon mortgage. Balloon mortgages are popular with individuals that plan on moving in five to seven years. Here's why:
Your monthly payments in a balloon mortgage are typically lower than the traditional 30-year fixed-rate mortgage. At the end of the term though (usually five to seven years), you are required to pay the mortgage off in full. You can also take advantage of lower interest rates (sometimes from three-eighths to three-quarters of a percentage point less than traditional fixed-rate loans) for that time period.
If your plans change, and you end up staying in your home longer then the five to seven years, you'll either have to pay off the balance, or, more likely, refinance your loan at the interest rate available then. Many lenders do offer an option that allows you to switch your loan to a fixed-rate mortgage if the certain conditions are met.
Qualifications for a balloon mortgage vary depending on the lender you choose, but most require at least a 20% down payment.
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FHA & VA Loans (also known as Government Loans)
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If you are veteran and looking to purchase a modestly priced home, there is a mortgage called the VA loan. This mortgage allows you to purchase a lower priced home with a much smaller down payment. Ask your lender what the cap is on the size of home you can purchase with the VA loan.
There is also a loan available to Americans with smaller incomes. It is the FHA, or Federal Housing Administration loan. There price caps on these loans too, so check with your lender.
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