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Lowering the interest rate on existing mortgages, combining a first and second mortgage into one loan with one payment and taking equity out of the property are a few reasons why homeowner’s refinance their mortgages. Paying off credit card debt through a mortgage refinance or a HELOC (home equity line of credit) will usually lower your overall payments and could have tax benefits. Discuss the decision with your accountant to see if the savings are applicable to you.
Jumbo and conforming mortgages
Any residential mortgage that exceeds the $453,100 limit set by Federal National Mortgage Association and Federal Home Loan Mortgage Corporation (Fannie Mae and Freddie Mac) is a jumbo loan. Jumbo mortgages are usually priced 25 to 50 basis points higher than conforming loans. Any loan below the $453,100 limit is considered conforming. Both jumbo and conforming loans are offered as fixed and adjustable rate mortgages.
Fixed or adjustable mortgage?
In a low interest rate market, homeowners tend to refinance away from an adjustable rate mortgage to a fixed rate mortgage to lock in a low interest rate for years to come. If you are not planing to keep the house for years to come, refinancing with an adjustable rate loan at a lower interest rate should be considered as an option. The benefit of a fixed interest rate mortgage is the security of a fixed payments for the duration of the loan while the advantage of an adjustable rate mortgage is the lower monthly payments.
Fixed rate mortgages
The interest rate on a fixed rate mortgage never changes. The most common fixed rate mortgages are fixed for 30, 20 and 15 years. Usually the shorter the amortization period the lower the interest rate. The major benefit of a fixed rate mortgage is the security of fixed payments (principal and interest) for the life of the loan.
Adjustable rate mortgages (ARM)
Or Hybrid ARM loans carry a fixed interest rate for a predetermined period after which it will convert to an adjustable rate mortgage. The fully indexed rate is index (usually treasury bill or libor) + margin (a predetermined rate). The margin will vary based on a number of factors such as credit score, LTV, property type and etc. Popular adjustable rate mortgages are:
- 3/1 (rate is fixed for the first 3 years)
- 5/1 (rate is fixed for the first 5 years)
- 7/1 (rate is fixed for the first 7 years)
- 10/1 (rate is fixed for the first 10 years)
Adjustable rate mortgages are amortized over a 30 year period.
Common terms important to understanding adjustable rate loans and calculating potential future costs:
- Initial interest rate is the beginning interest rate on an ARM.
- Adjustment period is the amount of time between interest rate adjustments of adjustable rate mortgages. The rate resets at the end of this period and the monthly payments will be recalculated.
- Interest rate cap is the limit on how much the interest rate can change at the end of each adjustment period or over the life of the loan.
- X/Y is the how Hybrid arm loans are referred to. X is the number of years during which the initial interest rate is fixed prior to the first adjustment and Y is the interval between adjustments (common terms are 1 for one year and 6 for six months). For example, a 5/1 ARM means that the initial interest rate is fixed for five years (or 60 months) and after the 60th payment the interest rate will be adjusted annually.
- Fully Indexed Rate is the actual interest rate of the loan after the fixed period. Index + Margin = Fully Indexed Rate.
- Margin is added to the index to calculate the actual interest rate. The lower the margin the lower the fully indexed rate.
- Index is a published financial index such as the treasury bills or libor used to periodically adjust the interest rate.
- Start Rate the introductory rate for some adjustable rate loans. The start rate is like a teaser, because the initial interest rate is lower than the actual rate.
- Payment Shock is the industry term for the increase in monthly mortgage payments generally caused by changing interest rates.
- Cap is any clause that sets a limitations on the amount and or the frequency of rate and payment changes.