Mortgages Decoded: Fixed, Variable, Adjustable, Interest-Only
When applying for a mortgage, one of the variables to consider is the rate, which refers to the interest charged on the loan. Market forces set the overall level of mortgage rates, which can rise and fall daily with interest rate cycles. Economic factors such as current and expected rates of inflation, unemployment, and other indicators and trends affect the overall rate environment and the homebuyer’s market.
In general, when the outlook is for fast economic growth, higher inflation, and low unemployment rate, mortgage rates tend to rise. When the economy is slowing down, inflation is falling, and unemployment is rising, mortgage rates generally fall.
Mortgage rates can vary between different lenders. Each lender sets their own mortgage rates based on the overall rate environment and other factors that may be specific to the financial institution.
Types of Mortgage Rate Structure
There are several types of rate structure commonly available in the mortgage market – fixed, variable, adjustable, and interest only. Your mortgage lender can help you determine which type of mortgage is best for your situation.
The interest rate charged on a mortgage is based on an index rate (often referred to as the benchmark interest rate) plus a margin. One common index is the prime lending rate.
Fixed Rate
With a fixed rate mortgage, the rate does not change over time. The rate specified in the contract is the rate for the life of the loan. With a fixed rate loan, you always know the amount of the monthly payment for principal and interest. If your lender collects escrow payments for real estate taxes or insurance, that portion of the payment could still vary based on changes to tax rates and real estate values in your municipality or changes in insurance coverage or premiums.
If rates have fallen since you took out a fixed rate mortgage and you want to take advantage of a lower rate, you would need to refinance your mortgage. Refinancing is the process of applying for a new mortgage and paying off the old mortgage.
Variable Rate
With a variable rate mortgage, the mortgage is tied to an underlying interest rate index, and the interest rate on the mortgage could change periodically as the rate index changes. The frequency of the rate change and the specific index the mortgage is tied to are specified in your mortgage agreement.
A variable-rate loan can be beneficial in an environment of declining rates. In an environment where rates are increasing, the rate on a variable rate mortgage will increase, and as a result, so will the monthly payment.
Adjustable-Rate Mortgage (ARM)
An adjustable-rate mortgage (ARM) is a hybrid of the fixed and variable rate types of mortgages. With an ARM, the interest rate is fixed for a specified length of time, then adjusts monthly or annually according to the index the loan is tied to for the remainder of the loan term.
The frequency of the rate adjustment and the specific index the mortgage is tied to are specified in your mortgage agreement.
Interest-Only
An interest-only mortgage requires monthly payments of only the interest for a specified period, usually the first 10 years of a 30-year loan. The monthly payment is lower because during this time, the original loan amount (principal) is not paid down. The interest rate can be fixed, variable, or adjustable.
Interest-only loans are appealing to buyers who don’t plan to own a property for a long time, or those who plan to make major upgrades and refinance in a few years.
For information about mortgage programs offered by Enterprise Bank, visit https://www.enterprisebanking.com/personal/loans/mortgage or contact The Mortgage Center at Enterprise Bank at 877-671-2265.