Deciding which mortgage to apply for when you need help financing your home (as most people do) can be tricky, particularly when you’re a first-time home buyer. The process is made all the more difficult with the use of pesky terms that only financial gurus can understand.
Luckily for you, the bloggers from online brokerage Movoto Real Estate have come to the rescue. Here we decode five mortgage terms every borrower should know.
1. Adjustable-rate mortgage (ARM)
An adjustable-rate mortgage is a loan with an interest rate that changes from month to month during the term of the loan based on market conditions.
Since the rates of an ARM are based on the status of the economy, whether you apply for one or not should depend on how the market looks. Here are a few guidelines for choosing an ARM:
- Pick when interest rates are falling
- Take advantage of historically low market rates (like those currently occurring)
- Avoid when rates are presently low but seem likely to rise in the near future
Know that an adjustable-rate mortgage is optimal when rates are dropping, and not such a smart choice if interest trends are steadily rising.
2. Hybrid Loan
This form of loan combines an adjustable-rate mortgage with its fixed-rate counterpart. The mortgage starts out with a fixed interest rate for a set amount of time (from five to seven years), and then transitions to an adjustable rate for the remainder of the term.
Why might a hybrid loan be a good option? For starters, the initial fixed low rate allows the home buyer to save money on mortgage payments.
Additionally, if you purchase a home while interest rates are high, with a hybrid loan you’ll get the benefit of low rates early on plus lower rates after the mortgage transitions to an ARM. This is because the economy works in a cyclical pattern, and what goes up must eventually come down–to your benefit, with a hybrid loan that starts at the right time.
3. Lock in a Rate
Also known simply as “locking in,” this phrase refers to the status of your interest rate. If you select a type of mortgage and decide to lock in your rate, it means that you are agreeing to the current interest rate as what will be applied to the life of your loan.
The opposite of locking in is to float your rate, which means that you do not yet agree to a specific interest rate, typically because you hope that waiting longer will reward you with a lower rate.
4. Points (and Caps, and Steps)
There are a number of terms used with mortgages that have definitions relating to, but not necessarily synonymous with, how you would define them in another context. This includes what are called points, as well as caps and steps.
Here are basic explanations of each:
- Points: Equal to one percent of a loan, and exist on some loans as an option to lower the interest rate by paying points upfront.
- Caps: A limitation on how much interest can rise within a predefined period. A cap is generally only applicable to ARMs, where the rate is constantly adjusting based on the market.
- Steps: Similar to a cap, it limits how much an interest rate can increase or decrease during an adjustment period. A step correlates to the interest rate itself, so with a 1.5 step the interest can only vary by 1.5 percent during each period.