Buying a home can be like learning a new language. The new lingo, new concepts can be a lot to wrap your head around. It can be confusing to sift through the various mortgage products on the market today. When you’re ready to buy a home, you want to get the best mortgage rate to keep your monthly payment down. But what kind of mortgages are out there and how can you get the best rates?
Average mortgage rates in the US
The mortgage markets in the US is highly competitive, which means borrowers can benefit from relatively low interest rates that come with loans. According to Freddie Mac, the average monthly interest rate for a 30-year fixed mortgage is 3.94%.
How are mortgage rates calculated?
Interest on mortgages is generally paid monthly, which means you can divide the annual interest rate by 12. For example, if you took out a mortgage of $600,000 at 6.5% interest over 30 years, you’d pay a monthly rate of 0.54% — interest on your principal.
For the first repayment, you would pay $3,240 interest plus principal. Each consecutive month, the principal would be less, meaning you’ll pay less interest.
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What are the different mortgage rate types?
If you’re ready to start looking for your new home, explore the types of mortgage that are out there and see what works best for you. The most common mortgages are the adjustable rate mortgage (ARM) and the fixed rate mortgage (FRM), and more and are outlined below:
1. Adjustable rate mortgage (ARM)
Also known as a variable rate mortgage, an ARM is a home loan with an interest rate that fluctuates with market interest rates. Lenders often offer a low fixed-interest rate on the front end of your loan — anywhere from 10 months to 10 years, depending on your contract. This may seem like an attractive offer, but because your interest rate is not fixed, you’re taking on some uncertainty in knowing exactly how much you’ll pay each month over the life of your loan.
The biggest risk you take with an ARM is that they’re hard to understand. Lenders can confuse you with the jargon that affects your loan and payment. So, not only will you be braced with uncertainty of when and how much your payments will go up (or down) — good chance you won’t know why.
2. Hybrid adjustable rate mortgage (ARM)
A hybrid ARM is just that — the uncertainty of an adjustable rate combine with the predictability of a fixed rate mortgage. A lender will offer a hybrid ARM with an initial fixed interest rate for a certain period of time — meaning your rates stay the same for five, seven, 10 or 15 years. Once that time is up, you’re rate will change due to the market rates, and stay that way for six months or a year. If you have poor credit, this may be the only mortgage you qualify for.
Hybrid ARMs look like this:
- 5/1 ARM: First change after five years, then adjusts every year.
- 5/6 ARM: First change after five years, then adjusts every six month.
- 7/1 ARM: First change after seven years, then adjusts every year.
- 10/1 ARM: First change after 10 years, then adjusts every year.
- 15/15 ARM: First and only change after 15 years.
How can I make sense of the Hybrid ARM rates?
The most popular ARM is 5/1 which has an introductory rate for five years. After this period, the interest rate adjusts once a year. Other common fixed rate periods for ARMs are 3/1 and 7/1.
2. Fixed rate mortgage (FRM)
A fixed rate mortgage is the most common mortgage, with an interest rate that stays the same for the life of the loan. This means that both the payment amounts and the loan term — usually 10, 15 or 30 years — are fixed. With an FRM, you have the security and peace of mind knowing what your payments will be each month, allowing you to budget more effectively. These rates can often be higher than the ones offered for ARMs, but you won’t be living with the uncertainty of fluctuating interest rates.
3. Interest-only mortgage
If you take out an interest-only mortgage, you’ll pay only the interest on the loan over five to 10 years, and none of the actual loan amount. When the term is up, you can either pay the principal or convert it to an interest and principal loan (amortized) for the remaining life of the loan.
So, if you had a 30-year mortgage and the first 15 years were interest-only, the principal balance would be amortized for the remaining 15 years.
People opt for interest-only loans because it gives you a lower payment in the first few years of your loan, giving you more money for things like furnishing or improving your home. However, interest-only mortgages are riskier for lenders, strapping you with higher interest rates.
5. Negative amortization mortgage (NegAm)
If you decide on a NegAm you’ll make smaller payments each month, paying only the principal amount — not the interest. But that doesn’t mean you’re off the hook. That interest you didn’t pay gets tacked on to the total amount you borrowed — and it’s subject to interest. So you’ll be paying interest on interest.
A NegAm could give you money upfront and giving you a reliable monthly payment, but beware. If the interest rates rise, the equity in your house will decline. And instead of paying down your debt with each mortgage payment, you’re actually adding on to it.
6. Balloon payment mortgage
Balloon payment mortgages are when a lender gives you a lower interest rate and monthly payments for the term of the loan — usually five or seven years. When that term is up, you pay the remaining balance. It’s called “balloon” because of the size of that payment is often quite large.
These loans can benefit you if you’re sure your financial situation will improve, or you plan on selling the property in a few years — before your term is up. But, balloon payment mortgages are risky. They were popular before the mortgage crisis in 2007, and the one that caused many to default.
Interest rates vs. APR
When you’re looking to take out a mortgage or refinance, you’ll see both APR and interest rates — they’re not the same thing. The interest rate, expressed as a percentage, is the fee that you’ll pay to the lender to borrow. The APR, usually higher than the interest rates, is what you pay the lender annually and includes fees like mortgage insurance, discount points, loan origination fees and closing costs.
When you’re shopping for a mortgage, comparing the APRs will give you a better sense of the cost of the mortgage. The higher the APR usually means higher fees and costs.
Conforming vs. non-conforming mortgages
When deciding on your mortgage, it’s best to go with a conforming mortgage — but what does that mean?
Conforming loans usually come with lower interest rates and lower fees. These loans need to meet standards set by the government sponsored agencies, Fannie Mae and Freddie Mac. And limits can vary according to the housing market — but they’re usually less than $424,100 in most areas.
So if you want to purchase a home under the loan limit you’ll be more likely to qualify, you’ll can have lower interest rates and may even be able to make a lower down payment.
Nonconforming loans are loans that are over the limit are considered jumbo loans. Because these tend to be a higher risk for the lender, they come with high interest rates, require a higher down payment and look closely at your credit before you can qualify.
How can I apply for a mortgage?
Once you’re ready to apply for a mortgage, you can’t do it alone. Contact your bank or mortgage broker who can set you up with an underwriter. They’ll assess your needs and options to help you find the right loan.
To apply for a loan, you’ll need to provider your lender with personal information including:
- Your name.
- Your income.
- Your Social Security number.
- The address of the home you plan to purchase or refinance.
- An estimate of the home’s value.
- The amount you want to borrow.
When it’s time to apply for a mortgage, make sure you understand the loans you qualify for, and decide on the one that works best for you. Knowing the basics of the kinds of mortgages out there can give you a leg up with the lender, and could save you money and struggles down the road.