Loan Term and Fixed or Adjustable Rate Options Explained
The term of the loan is the amount of time you’ll have to repay your mortgage. The longer the loan term, the lower the monthly payments.
There are a handful of different loan terms offered that are specific to a fixed rate conventional mortgage. The most common being 15, 20 and 30 year terms. FHA and VA offer 15 and 30 year terms.
• With a 30 year fixed loan, you’ll repay the loan in 360 monthly payments. This is the most popular choice.
• 15 and 20 year fixed rate mortgages offer shorter loan terms that allow you to pay off your home and build equity faster. The 15 year fixed is the 2nd most popular term.
• The shorter the loan term, the lower the interest rate, as compared to a 30 year fixed; However, even though the interest rate is lower, the monthly payment is higher since it’s is repaid in 180 or 240 monthly payments.
• On a $500,000 loan amount at 4% the monthly payment on a 30 year fixed is $2,429 compared to the payment of a 15 year fixed of $3,763.
Fixed Rate vs Adjustable Rate Mortgages (ARM)
Most borrowers decide on the stability of a fixed rate loan, as the rate and payment remain the same for the life of the loan. In our current market, with relatively low interest rates, fixed is more popular.
If you’re confident you’ll only own your home for a few years, an adjustable rate mortgage might be a good fit for you, offering a lower interest rate for a set fixed period at the beginning of the loan.
• ARMS are 30 year loans and start off with a slightly lower interest rate vs. a 30 year fixed. They offer a fixed rate and payment for the first 3, 5, 7, or 10 years, then they become adjustable for the remainder of the loan term.
• The interest rate on an ARM is comprised of an index plus a margin. The index is a benchmark interest rate that mirrors current market conditions and fluctuates. The margin is a fixed percentage set by the lender.
• A popular index is the 1 Year LIBOR (London InterBank Offered Rate) published in the Wall Street Journal, and a common margin is 2.50%. If your loan was at the end of the initial 3-5-7-10 year period now, and today’s 1 Year LIBOR is 2.670% and the margin is 2.5% your interest rate would adjust from the initial fixed rate to 5.170%.
• They adjust once per year, resulting in your mortgage payment increasing or decreasing annually. They do have a lifetime cap which is typically 5% of the interest rate during the initial fixed term. If your starting rate is 4% and the cap is 5%, it can never go higher than 9%.