Mortgages are nearly a lifelong commitment. Considering many couples enter into their first long term mortgage at the age of 28, they can expect to have their home paid off at age 48, 58 or 68. Why? Mortgage loans amount to hundreds of thousands of dollars. The average fixed mortgage loans in the USA are $250,000. It’s impossible to pay off $250,000 in 15 years. Moreover, interest rates fluctuate so much during normal economic times, when tough economic times come, bringing down the interest rate, many people are smart to get fixed mortgage loans. So getting a fixed mortgage explanation is crucial when you’re house hunting.
Loans fall into 3 categories (and many subcategories); fixed rate, ARM or variable rate mortgages and balloon mortgages.
ARMS or variable rate mortgages have may have a fixed interest rate for a short period of time and then, usually, the interest fluctuates with the “prime rate”. The prime rate is set by the Federal government. Many people try and get a variable rate mortgage first because it has the lowest interest rate (besides a balloon). This is because even if mortgage rates rise, they have a good chance of paying off more of the total loan during a time period where the interest rate is lowest. Often you’ll see a loan called a 2/30 arm which is two years at one rate and then the rest of the loan is variable. While this is sometimes a very wise choice, it’s also very risky. The prime rate can vary in a single day, let alone a three year period. With good credit, a variable rate loan will start out as low as 1-2% interest if the prime rate is around 3% (this is a rough calculation and not exact!).
Balloon payments are similar to a 2/30 ARM only they can have the fixed rate and are not for 30 years. Generally a balloon payment loan has anywhere from a 5-10 year period to be paid. At the end of the life of the loan, the entire loan is due. Because of the short amount of time, these types of loans are generally lower interest. They are also only good for couples that are going to flip the house quickly (sell the house at a profit) or for commercial developers.
The last term you probably hear the most is a 30 year fixed mortgage. This is because it is the most common type of loan. The 30 year mortgage is an amortization schedule (the schedule of payments that ultimately lead to the paying off of a loan) is in place because it reduces the monthly payments to manageable levels for borrowers. Buying a $250,000 house is an expensive proposition (that’s the average cost of a home in the USA) and a 20 year mortgage makes the monthly payment $1622.39 at around 4.8% interest. That interest rate is assuming a FICO score of at least 650 by the way. Change the amortization to 30 years and payments drop to $1311.66 a month. The total interest paid is a lot more (nearly $100,000), but overall the monthly mortgage payment is manageable by most borrowers.
Remember that these figures aren’t representative of a true amortization table. They are only rough estimates. True calculations must factor in points (fees charged by percentage of the total loan), closing costs and other factors. I hope this explanation of a 30 year fixed rate mortgage is helpful!