What Types of Loans Should I Know About When Buying a House?
What’s the difference between a fixed-rate and adjustable-rate loan? What about jumbo?
Thinking about purchasing a home? One of the decisions you’ll need to make is whether you want a fixed-rate or adjustable-rate loan. Depending on the price of the home you’re looking for, you may need a jumbo loan.
First, let’s define these terms so you have a better understanding of your options.
A fixed-rate loan is a type of mortgage loan in which the interest rate does not change during the term of the loan. This holds true regardless of the duration of the loan, which could be 15 years, 30 years, or any other term length that the lender offers.
An adjustable-rate mortgage, or ARM, is a loan in which the interest change may change from time to time, based on market conditions. If the benchmark interest rate declines, your interest rate could also drop, meaning you could enjoy lower payments. However, if the benchmark interest rate rises, the interest rate on an ARM will also rise.
While “fixed” and “adjustable” refer to the interest rates on a mortgage, “jumbo” refers to the amount that’s being borrowed. A jumbo mortgage is a loan for an amount that’s outside of federally-determined conforming loan limits.
The Details of a Fixed-Rate Loan
Your mortgage consists of four parts: principal, interest, property taxes and homeowner’s insurance. If you hold a fixed-rate loan, the principal and interest portion of your mortgage will remain locked for the entire duration of that loan. The property taxes and insurance, however, are outside of the lender’s control. Those may (and likely will) change over time.
Can market crashes or the federal funds rate change my loan?
If you hold a fixed-rate loan, changes to the federal funds rate (the rate at which the federal government loans money to institutions) will not affect your loan. Likewise, major economic changes like market crashes or rampant inflation also will not affect your loan’s interest rate. Your interest rate is “fixed,” regardless of what happens in the overall broader economy.
What if my credit score drops, or I lose my job?
As long as you remain current on your mortgage payments (meaning that you make on-time payments in full), your future creditworthiness, income, and debt-to-income ratios will have no impact on your mortgage.
What if I refinance?
Refinancing a loan means that you “close” the current loan and open a new one. This means that the terms and conditions of your current loan will end.
The Details of an Adjustable-Rate Loan
ARM rates are determined by two factors – the benchmark that it tracks, plus an additional margin added by the lender. Common benchmarks include the London Interbank Offered Rate (LIBOR) and the Cost of Funds Index (COFI).
Are there limits to how much – and how often – this changes?
Yes. ARMs are issued by locking the number of months or years in which you’ll pay the initial interest rate. This could be as short as one or two months, or as long as five or more years.
What is an adjustment period?
The interest rate on an ARM can only be raised after specific predetermined amounts of time. This is known as the adjustment period and can range from a few months to many years.
What’s the periodic adjustment cap?
Each rate hike will be “capped” at a specific threshold. This is called the periodic adjustment cap. Furthermore, the maximum interest rate that the ARM could ever charge is also limited. This is known as the lifetime cap.
The Details of a Jumbo Mortgage
A jumbo mortgage is a loan for an amount that’s outside of federally-determined conforming loan limits.
These are determined based on the county in which the property is located. In most countries in the U.S., a jumbo mortgage is any loan above $417,000. In more than 100 of the nation’s highest-priced countries, including many counties around L.A., San Francisco and New York, a jumbo loan is an amount over $625,500. There are also more than 100 other counties that have loan limits priced in-between those two.
Jumbo loans typically require higher down payments and stronger creditworthiness standards. Many jumbo loans require two appraisals, rather than only one.
A jumbo loan refers only to the borrowed amount – not the repayment terms. Fixed-rate and adjustable-rate mortgage refer to the repayment terms – specifically with regard to interest rate changes or lack thereof.
Which Loan Should I Choose?
Learn about all your lending options by talking to your real estate agent, mortgage banker and financial advisor. Take a careful look at your budget and goals. Then make a careful decision, weighing all the available options.
Get more information on the home buying process.
Victoria Keichinger is the Vice President, Brand Marketing for Coldwell Banker Real Estate. When she's not managing national media and advertising for the Coldwell Banker brand at work, she finds herself most at home in Jersey City, NJ with her pre-school crush turned spouse and son. A true Francophile, she loves to travel and will go anywhere there are ski slopes.