$company_name offers several financing methods. Most financing methods contain different features that can be confusing for even experienced homeowners. The most common finance methods include:
Fixed Rate | ARMS | Temporary Buydowns
The interest rate on a Fixed Rate Mortgage remains fixed for the life of the loan, and monthly payments of principal and interest payments never change.
The most common fixed rate terms include the 30-year term and 15-year term. In general, with a shorter the term, the interest rate will be lower but the principal and interest payment will be higher. Therefore, the interest rate on a 15-year term loan is lower than the rate of a 30-year term loan, however, the principal and interest payment on a 15-year term is higher than the payment on a 30-year term.
Distinction between 15-year fixed term and 30-year fixed term
Adjustable-rate mortgages (ARMs) became popular in the early 1980s when interest rates were much higher. When lenders were offering fixed rate mortgages at 15 percent to 16 percent, over 60 percent of homebuyers chose ARMs with interest rates starting at 12 percent to 13 percent. Currently with low fixed rates, most lenders reported that fewer than 15 percent of homebuyers were financing their homes with ARMs.
ARMs are good to consider when:
Adjustable-Rate Mortgages
The obvious difference between an adjustable rate mortgage and a traditional fixed rate mortgage is that with an ARM, the interest rate goes up and down. It changes according to a set of formula (typically one year) for the life of the loan. Usually, your monthly payment goes up and down with the interest rate.
An ARM, much like a new home, has some basic features and a number of options.
Basic Features:
Optional Features:
Index
An ARM's interest rate goes up and down according to a nationally published index. Your lender has no control over the index and cannot arbitrarily adjust your rate. Your rate is determined by the index.
Different ARMs have different indexes, but the One-Year Treasury Bond Index is the most common ARM index. Other indexes are:
Margin
Your ARM's interest rate is the sum of the index value plus the margin. Your lender sets the ARM's margin before settlement of your loan. Once set, the margin does not change for the life of the loan. In a hypothetical example if the margin is set at 2.75 percent and the index is 4.75 percent, the rate for the following year becomes 7.50 percent (2.75 percent plus 4.75 percent).
Adjustment Interval
The interest rate of an ARM changes at fixed intervals which is called the adjustment interval. Different ARMs have different adjustment intervals. The interest rate of most ARMs adjust once a year, but others adjust every month, six months, three years or five years. An ARM whose rate changes once a year is called a "one-year ARM". The graphed example is a one-year ARM.
Sometimes the first adjustment interval is longer or shorter than the following intervals. For instance, an ARM's interest rate might not change for the first three years, and then change once a year thereafter. Or the initial rate might change after ten months rather than a year.
Initial Interest Rate
The final feature common though all adjustable rate mortgages is the initial interest rate. This is the rate that you pay until the end of the first adjustment interval. The initial interest rate also determines the size of your starting monthly payment. The initial interest rate for most ARM's is lower than standard fixed rates.
Often the initial interest rate is lower than the sum of the current index value plus margin. When it is several percentage points lower, it is called a teaser rate. If your ARM starts with a teaser rate, your interest rate and monthly payment will increase at the end of the first adjustment interval unless your ARM's index goes down.
Optional Features
Most ARMs have consumer protection options that limit the amount that your interest rate and monthly payment can increase. They are called caps.
Periodic Interest Rate Cap
The first type of cap is the periodic interest rate cap. It limits the amount an ARM's interest rate can change from one adjustment interval to the next. If the periodic interest rate cap is two percent, this means that the ARM's interest rate cannot go up more than two percent. Without a periodic interest rate cap, the ARM's rate could exceed that amount if the index moves more than the amount of the periodic interest rate cap.
Life Interest Rate Cap
The second type of cap that you want on an ARM is the life interest rate cap. It sets the maximum interest rate that you can be charged for the life of the loan. If the life interest rate cap is 12 percent and the index value plus margin equals 13 percent, the life cap would limit the rate increase to 12 percent. Even if the index went to 16 percent, as the One-Year Treasury Bond Index did in 1982, the interest rate of this ARM would still be limited to 12 percent.
Typically the life cap is quoted as percentage points over the initial interest rate (i.e., a "six percent life interest rate cap" means five percent over the initial rate).
Initial Adjustment Rate Cap
If an ARM has an initial fixed period of more than one year, a lender may provide that the first adjustment exceeds the periodic interest rate cap. This means the initial adjustment could raise your interest rate and payment substantially, but never more than the life interest rate cap.
Conversion Option
This provides the borrower with the opportunity to convert their ARM rate to a fixed rate during a specified time period. Typically, the borrower must have had the loan for the fixed period of the loan plus one or more years. The conversion option also provides for the fees to be paid and a rate formula to determine what the new fixed rate will be. That rate may be higher than fixed rates available by refinancing but it may eliminate other closing costs encountered with a refinance.
Temporary buydowns are a tool for borrowers purchasing a home who don't have enough income, relative to their monthly mortgage payment and other expenses, to meet lender requirements. To use a temporary buydown, the borrower must have access to extra cash. The cash can be the borrower's or it can be contributed by a home seller anxious to complete a sale. The cash used for the buydown funds an escrow account from which the payments, that supplement the borrower's payments, are drawn.
While the borrower's payments are reduced in the early years, the payments received by the lender are the same as they would have been without the buydown. The shortfalls from the borrower are offset by withdrawals from the escrow account. Lender paid temporary buydowns are also available and the escrow funds are typically derived from “Negative Discount Points” obtained by offering a higher note rate. That means the rate from years 4 through 30 are normally higher that a typical fixed rate loan.
Temporary buydowns are not a type of mortgage. They are an option that can be attached to any type of mortgage. Most temporary buydowns, however, are attached to fixed-rate mortgages.
Temporary versus Permanent Buydowns: Another way in which borrowers with excess cash can reduce their mortgage payment is by paying additional points in order to reduce the interest rate. This is sometimes called a “permanent buydown” because the reduced payment holds for the life of the loan. For the same number of dollars invested, however, temporary buydowns reduce the monthly payment in the first year, which is the payment used to qualify the borrower, by a larger amount than a permanent buydown. This reflects the concentration of the payment reduction in the early years of the loan.
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Payments by Borrowers and Payments from Escrow Accounts on a $100,000 30-Year |
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| Year | Payment Received by Lender | 3-2-1 Buydown | 2-1 Buydown | 1-0 Buydown | |||
| Payment by Borrower | Payment from Escrow | Payment by Borrower | Payment from Escrow | Payment by Borrower | Payment from Escrow | ||
| 1 | $665.31 | $477.42 | $187.89 | $536.83 | $128.48 | $599.56 | $65.75 |
| 2 | $665.31 | $563.83 | $128.48 | $599.56 | $65.75 | $665.31 | 0 |
| 3 | $665.31 | $599.56 | $65.75 | $665.31 | 0 | 0 | 0 |
| 4-30 | $665.31 | $665.31 | 0 | 0 | 0 | 0 | 0 |
| Needed Escrow | $4,585 | $2,331 | $789 | ||||
The table illustrates the three most common temporary buydowns. On a 3-2-1 buydown, the mortgage payment in years one, two, and three is calculated at rates 3%, 2%, and 1%, respectively, below the rate on the loan. On a 2-1 buydown, the payment in years one and two is calculated at rates 2% and 1% below the loan rate. And on a 1-0 buydown, the payment in year one is calculated at 1% below the loan rate.
The 3-2-1 buydown involves the largest reduction in the borrower's payment in the first year, but also requires the largest amount placed in escrow, as shown on the bottom line.
