Shopping for a loan?
Walking into a store and finding the perfect pair of shoes in just your size is great when it happens, but more often than not you’ll be shopping around for the right style and right fit. Mortgages are no different – rates change, products change and so do a buyer’s needs. Taking a good look around at different options before committing is always a smart thing to do.
Fixed Rates
Fixed rate is your standard mortgage product. You select a time period and the rate available is there for the life of the loan. Each month, you pay a combination of principle and interest. The early payments have a large percentage going towards interest and over the life of the mortgage, the payments adjust to less interest and more principal. 30 years is pretty standard but shorter terms are available. A 15 or 20-year mortgage will save you on interest but monthly payments will be higher.
Most fixed-rate loans can be prepaid as much as you want. Your monthly payment would stay the same but you would make additional payments towards the principal, reducing the amount of years you would carry the loan, thereby saving on interest.
If you were looking at a $500,000 loan, here’s an example of how it would work:
30 year fixed 6.5% $3,160/mo.
20 year fixed 6.375% $3,691/mo.
15 year fixed 5.875% $4186/mo.
You can see the difference in payments and how rates get adjusted according to the timeframe.
Adjustable Rates
An Adjustable Rate Mortgage (ARM) is just what is sounds like: you start at one rate and it gets adjusted after a set period of time.
Adjustable rate mortgages come in 3, 5, 7, 10 and 15 year options. They are written like this: 5/1, 7/1, 10/1, 15/1. This means that the loan is set for the initial amount of years and then adjustable every year after that for the life of the loan. They also have an annual cap, lifetime cap and floor, percentages above or below which the rate can’t go.
The difference in rates between the fixed-rate and adjustable can be pretty substantial – an ARM can be .50% – .75% lower than the fixed (although not in this high-rate environment). The 10/1 and 15/1 ARMS are typically .25% – .375% lower than the fixed, while the 3/1, 5/1 and 7/1 can be lower by .375% – .75%.
An Adjustable Rate Mortgage (ARM) is a great product for certain situations, like when interest rates rise. The introductory rate for an ARM is lower than a fixed-rate loan but the tradeoff is that your ultimate interest rate is unknown. This is a benefit in a market with high interest rates because ultimately, the rates can’t go any higher and they start to come down again. It’s a drawback when interest rates are on the lower side and you run the risk of rates being higher when it’s time for your rate to be adjusted. Sounds like a gamble, but an ARM can save you money on your interest, help you get principal paid off sooner or allow you to buy at a higher price point. The only way to know if it will work for you is with the input from an experienced mortgage broker.
For more thorough information on ARMS, please see our ARM blog post of 5/6/23.
Interest-Only Loans
For the most flexible option in paying off a mortgage, there’s an interest-only loan and they are just what they sound like – you are only required to pay the bank the interest due on what you borrowed for the initial loan period.
Some situations where this scenario works well is if you need lower monthly payments, if you only plan on having the house for a few years before re-selling, or if you have a decent salary but a large part of your income comes from an annual bonus. And you are not prevented from making payments towards the principal but you have the flexibility to do it when you want to, not when you are obligated to.
Both fixed-rate and ARMs have interest only option. With a fixed rate mortgage, you could get up to 10 years interest free depending on the length of your loan. With an ARM, 3, 5, 7, 10 years could potentially be interest only for the introductory rate time. But, when the adjusted rate goes into effect so does the payment of principal along with the interest, making for a large increase in monthly payment. This option is not the best for a long-term mortgage holder but can work well for someone planning to sell after a short period of time.
Home Equity Line of Credit
A Home Equity Line of Credit (HELOC) is typically a second mortgage against your home, although it can be a first loan too. The loan is for a certain amount and the mandatory payback is interest-only on the amount you use. An advantage, though, is that you can pay back principal and keep your line of credit open and usable. At the end of 10 years, it becomes a 20-year amortized loan adjusting monthly to prime or to prime plus margin.
Construction Loans
A construction loan is used to purchase land and build a home before you move into permanent financing. It can be used to purchase, tear down and build. The supporting documents for your project will be needed at the outset – building approval contracts, plans and specs, permits, survey and builder approval.
Rehab Loans
A rehab loan is similar to a construction loan in that you are getting into financing without having a habitable dwelling to move into. You would use a rehab loan to buy a house – not land – that needs work to make it livable or that just needs enough work that you would like to borrow the funds to accomplish the renovation. Like the construction loan, you would also need your documentation in place: building contract, permits, plans and specs, depending on scope of the project. If cosmetic and clean-up work only, permits might not be needed depending on the parameters of the lenders. But if you’re planning on doing your own construction work, this is not the loan for you as only third-party contractors are permitted by the bank.
Reverse
A reverse mortgage is what it sounds like – you use the equity in your home as a guarantee to a lender to get funds. See our blog on Reverse Mortages for a full explanation.
Conclusion
The lending market has options for everyone and the best way to figure out your own personal needs is by talking with an experienced mortgage broker.