Fixed Rate Mortgages: These loans have a fixed rate of interest over the entire term for which the loan has been disbursed. The term for these mortgages is typically between 10 to 30 years. The monthly interest payment on these loans is fixed and hence there exists a certainty about the repayment of the debt over the entire term of the debt. Another advantage of fixed rate mortgages is that the initial down payment required is very low, generally around 5% of the loan amount to be disbursed.
The disadvantage of this type of loan is that the rate of interest may be higher than that of a variable rate mortgage. If predictability of the interest payments is important, then it is advisable to consider securing a fixed rate mortgage.
Adjustable Rate Mortgages (ARM): As the name indicates, the interest rate on this type of mortgage fluctuates throughout the term of the loan depending on the interest rate scenario in the economy. The rate for an ARM is usually adjusted annually.
An ARM usually has caps, which restrict the rise in the rate to a certain level, both on an annual basis as well as over the entire term of the loan. For example, an ARM may have a cap of 1% every year and 5% over the term of the loan. This type of loan is best if the term of the loan is short, as the longer the term, the more the exposure to fluctuations in the interest rate. The index to which the variable rate is pegged should also be carefully considered.
Thus a variable rate mortgage can work out to be a cheaper option than a fixed rate mortgage, provided the borrower has given due attention to the risks involved.
Jumbo Loans: If the equity loan to be raised exceeds the federal guidelines set by Fannie Mae/Freddie Mac, then the loan is referred to as a jumbo loan. The limit set by the guidelines is different from state to state. The rates for jumbo loans are typically higher than those for other types of mortgages, as the lender has a higher risk due to the larger amount of the loan. The borrower should try not to exceed the guidelines, as this could mean a considerable savings in terms of interest outflows.
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