Cost for the use of a loan, usually expressed as a percentage of the loan, paid over a specific period of time. The interest rate does not include fees charged for the loan. See also: annual percentage rate (APR).
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Once you think through your goals and determine how much you can comfortably afford to pay each month, then it’s time to choose a mortgage. With so many different mortgages available, choosing one may seem overwhelming. The good news is that when you work with a responsible lender who can clearly explain your options, you can better select a mortgage that is right for your financial situation.
Here are the major mortgage types:
With a Glossary Term: fixed-rate mortgage, your Glossary Term: interest rate – and your monthly payment of Glossary Term: principal and Glossary Term: interest - will stay the same for the entire Glossary Term: term of the loan. This type of mortgage tends to be the most popular because it protects homeowners from the possibility of future monthly payment increases (a situation faced by borrowers who select an Glossary Term: adjustable-rate mortgage) and is very straightforward.
When might a fixed-rate mortgage make sense?
Most lenders today offer a fixed-period or “hybrid” ARM,—which is an adjustable-rate mortgage that features an initial fixed interest rate period, typically of 3, 5, 7, or 10 years. After the fixed-rate period expires, the interest rate becomes adjustable for the remainder of the loan term. Fixed-period ARMs are often named by the length of time the interest rate remains fixed.
Example: In a 5/1 ARM, the “5” stands for the five-year “introductory period,” during which the interest rate remains fixed. The “1” shows that the interest rate is subject to adjustment once per year after the introductory period and for the remainder of the loan term.
About the introductory period: The rate on this kind of loan tends to be lower during the introductory period, which could mean a lower starting monthly payment. However, when the introductory period ends, your rate will go up or down depending on changes in the financial Glossary Term: index to which your loan is associated. If considering an ARM, carefully consider your ability to handle potential increases to your rate, and consequently, your monthly principal and interest payment.
Caps: ARMs have both a periodic adjustment cap and a lifetime interest Glossary Term: rate cap. Periodic Glossary Term: adjustment caps limit how much a rate can increase in any given period. Most ARMs today only adjust annually, so a periodic adjustment cap is also known as an annual adjustment cap. Many caps allow a significant increase in each adjustment period and over the life of the loan, so despite having a cap, the increase in the monthly payment allowable under the cap may still result in “payment shock.” Such an increase may make it difficult, or impossible, for your to pay your mortgage on time if interest rates rise. If you’re considering an ARM, find out what the caps would be and then run the numbers to see if you could still comfortably afford the monthly payments allowable under the rate caps.
When might a Hybrid ARM make sense?
Interest-only mortgages are adjustable-rate or fixed-rate loans, which contain an Glossary Term: interest-only payment option during a set period in the first years of the loan, often the first 10 years. During the interest-only period, borrowers can delay making principal payments and make monthly payments that only repay interest. After the interest-only period ends, assuming that a borrower selected this option and made only interest payments, the monthly payments would significantly increase when the required monthly payments started to include principal plus interest.
If there were no principal payments made during the interest-only payment period, the unpaid loan principal wouldn’t be reduced. That principal would now need to be paid back in the remaining years of the loan, in addition to the interest due on the total balance of the loan. So the payment shock would be quite significant when the interest-only period ends.
In general, interest-only mortgages may be a good choice for only a small number of buyers with very special circumstances. Carefully consider payment shock when considering an interest-only payment option.
When could an I/O mortgage make sense?
FHA loans: FHA loans are government-insured loans that could be a good fit for homebuyers with limited income and funds for a down payment. Bank of America, an FHA-approved lender, offers these loans, which are insured by the Federal Housing Administration (FHA)Footnote 1.
(Please note: Bank of America offers FHA and VA refinance loans to existing Bank of America home loan customers only.)
VA loans: VA loans are offered by VA-approved lenders like Bank of America, and are insured by the Department of Veterans AffairsFootnote 2. To qualify for a VA loan, you must be a current or former member of the U.S. armed forces or the current or surviving spouse of one. If you meet these requirements, a VA loan could help you get a mortgage.
And finally, be sure to ask your mortgage loan officer if they offer affordable loan products or participate in housing programs offered by the city, county or state housing agency. You may be eligible for grants, flexible, lower down payment options and down payment and/or Glossary Term: closing cost assistance.Footnote 4