Fixed interest rates. Adjustable interest rates. Balloon notes. Discount points. Origination fees. So many things to understand and so little time? Many times, the lender will suggest you buy the interest rate on your loan down. Let’s see how to make sense of all this, !starting with some definitions:
Fixed rate mortgage: A mortgage with an interest rate that stays the same for the life of the loan.
Adjustable rate mortgage: A mortgage with an interest rate that fluctuates over the life of the loan, with an adjustable period ranging from six months to three years.
Balloon note: A mortgage with a short term fixed rate note of three-five years that at maturity either converts to a one year adjustable note or requires the remaining balance to come due.
Discount point: A fee that the lender charges the purchaser for receiving a certain interest rate (each point is equal to 1 percent of the loan amount). Also referred to as an Origination Fee.
Regardless of the loan program you choose, the discount points/origination fees will be determined by the interest rate you choose for that loan. For example, a 10 year fixed rate loan might be offered at 8.5 percent with 0 points, 8.25 percent with one point, and 8 percent with 2 points. An adjustable rate loan might be offered at 6.5 percent with 0 points, 6 percent with 1 point, and 5.5 percent with 2 points. In other words, the lower the rate for the same kind of loan, the more fees or points you pay to get it. Each loan has a rate offered at 0 points. This is the market rate for that type of loan. When you buy an interest rate below that, the lender charges you points to compensate for the lower interest rate.
The rate the lender charges as the market rate for each type of loan is determined by how much security the borrower wants in the interest rate. A 30-year fixed rate is the most secure and therefore has the highest market rate; the 1 year adjustable rate is the least secure and hence has the lowest market rate. Here are examples of different types of loans with their no interest fee rates: one year adjustable (5.5 percent), two year adjustable (7 percent), three year adjustable (7.25 percent), five year balloon (7.5 percent) seven year balloon (7.825 percent), 15-year fixed (8 percent) and 30 year fixed (8.5 percent).
Let’s collect our thoughts so far. For each type of loan, there is a market rate in which the loan has no fees (points) associated with it. The market rate is lowest for a 1 year adjustable (the most volatile type of loan) and highest for a 30 year fixed (the most secure type of loan). So, should we get a loan with points or not? That’s the dilemma. Let’s do some math and see if it helps us decide. We’ll use a 30 year fixed rate as our choice of loan, and let’s borrow $100,000. At 8.5 percent interest and 0 points, our monthly principal/interest (P/I) payment is $767 and fees are zero. At 2 percent interest and 2 points, our P/I is $734 and fees are $2,000. By paying $2,000 in fees (points), we’ll save $33 a month. In this scenario, it will take 60 months to recover our investment. Is it worth it? If you think so, I have some swamp land in Florida that’s just for you. If you need help email me via[email protected].
Adjustable vs. Fixed Rate Mortgage
|Term||FHA 1 yr||P/I||P/I||Fixed|
TERM: $100,000 loan
Ajdustable rate mortgage can go up or down 1% per year
Up to 5% over the lif e of the loan