The world of mortgages is a confusing one. Let’s see if we can shed some light on adjustable-rate mortgages or ARMs, 2-step mortgages, and balloon mortgages.
Looking for the basics of the home mortgage loan process? Check out this blog post first: Home Mortgage 101. Learning the Basics.
Considered a tad bit riskier because payments can change significantly, an adjustable-rate mortgage or ARM is a mortgage loan in which interest rates change based on a specific schedule after a “fixed period”. In exchange for the added risk associated with an ARM, you’re rewarded with an interest rate lower than that of a 30-year fixed rate.
One-Year Adjustable-Rate Mortgages
When acquiring a one-year adjustable-rate mortgage, you essentially have a 30-year loan where the rates change every year on the anniversary of the loan. Obtaining a one-year ARM can possibly allow you to qualify for a home loan that is higher and acquire a home that is more valuable. Many homeowners with extremely large mortgages can get the one-year ARM and refinance them each year. The lower rate allows them to buy a more expensive home, and they pay a lower mortgage payment so long as interest rates do not rise.
Adjustable-rate mortgage loans are considered to be rather risky because the payment can change from year to year in significant amounts.
10/1, 5/5, 5/1, 3/3, and 3/1 Adjustable-Rate Mortgages
10/1, 5/5, 5/1, 3/3, and 3/1 ARMs are mortgages where the monthly payment and interest rate remain the same for “X/” amount of years for the first part of the mortgage and then changes every “/X” amount of years after. For example, in a 5/5 ARM the interest rate is fixed for the first 5 years and then at the beginning of the 6th year, interest rates are adjusted every 5 years.
Sometimes called a “30 due in 5”, a 5/25 mortgage is when monthly payments and interest rates do not change for 5 years and at the beginning of the 6th year, the interest rate is adjusted with the current interest rate for the remaining life of the loan.
2-Step Mortgages & Balloon Mortgages
A 2-step mortgage is an adjustable-rate mortgage that has the same interest rate for part of the mortgage and a different rate for the rest of the mortgage based on the current market rate. Those who chose to take the 2-step mortgage usually have plans of refinancing or moving out of the home before the period ends.
Lasting for a much shorter term and working a lot like a fixed-rate mortgage, balloon mortgages tend to have lower monthly payments because of a large payment (the balloon) at the end of the loan and because you’re primarily paying the interest for that month. Balloon mortgages are great for responsible borrowers with the intentions of selling the home before the due date of the balloon payment and are often used by investors. However, homeowners can run into big trouble if they can’t afford the balloon payment, especially if they’re required to refinance the balloon payment through the original loan lender.
Before Signing The Dotted Line
Before agreeing to any particular loan, we highly recommend you get in touch with a professional mortgage broker who can help make sense of everything. Make sure you shop around to find the best possible rate for you, as a small difference in interest rates can lead to thousands of dollars in savings over the life of the loan.
Need a reference? We’ll point you in the right direction. And if you’re interested in seeking more information on ARMs, check out this free Consumer Handbook on Adjustable-Rate Mortgages.
Looking to buy a home? We can help in that department. Get in touch with us and we’ll work out the details together.
Questions? Let us know in the comments and we’ll do our best to answer them.
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