Finance Types
Plaza Loans offers several finance methods. Most finance methods contain different
features that can be confusing for even experienced homeowners. The most common
finance methods include:
Fixed Rate Mortgages
The interest rate on a Fixed Rate Mortgage remains fixed for the life of the loan
and monthly payments of principal and interest payments never change.
The most common fixed rate terms include the 30-year term and 15-year term. In general,
the shorter the term, the lower the interest rate and the higher the principal and
interest payment. Therefore, the interest rate on a 15-year term loan is lower than
the rate of a 30-year term loan, however, the principal and interest payment on
a 15-year term is higher than the payment on a 30-year term.
Distinction between 15-year fixed term and 30-year fixed term
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Adjustable Rate Mortgages
Adjustable-rate mortgages (ARMs) became popular
in the early 1980s when interest rates were much higher. When lenders were offering
fixed rate mortgages at 15 percent to 16 percent, over 60 percent of homebuyers
chose ARMs with interest rates starting at 12 percent to 13 percent. Currently with
low fixed rates, most lenders reported that fewer than 15 percent of homebuyers
were financing their homes with ARMs.
ARMs are good to consider when:
- You believe that rates are going to fall to levels much lower than they are today.
- You only plan to keep your home for two or three years, and an ARM looks less expensive
in the short term.
The obvious difference between an adjustable rate mortgage and a traditional fixed
rate mortgage is that with an ARM, the interest rate goes up and down. It changes
according to a set of formula (typically one year) for the life of the loan. Usually,
your monthly payment goes up and down with the interest rate.
An ARM, much like a new home, has some basic features and a number of options.
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Basic Features
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Optional Features
Periodic
Interest Rate Cap
Life Interest Rate Cap
Initial Adjustment Rate Cap
Fixed Rate Conversion Option
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An ARM's interest rate goes up and down according to a nationally published
index. Your lender has no control over the index and cannot arbitrarily
adjust your rate. Your rate is determined by the index.
Different ARMs have different indexes. The One-Year Treasury Bond Index is the most
common ARM index. Other indexes are:
Six-Month Treasury Bill
Three-Year Treasury Bond Index
Five-Year Treasury Bond Index
11th District Cost of Funds Index - COFI
London InterBank Offered Rate - LIBOR
Prime Rate
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Margin
Your ARM's interest rate is the sum of the index value plus the margin. Your lender
sets the ARM's margin before settlement of your loan. Once set, the margin does
not change for the life of the loan. In a hypothetical example if the margin is
set at 2.75 percent and the index is 4.75 percent, the rate for the following year
becomes 7.50 percent (2.75 percent plus 4.75 percent).
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The interest rate of an ARM changes at fixed intervals. This is called the adjustment
interval. Different ARMs have different adjustment intervals. The interest rate
of most ARMs adjust once a year, but others adjust every month, every six months,
every three years or every five years. An ARM whose rate changes once a year is
called a "one-year ARM". The graphed example is a one-year ARM.
Sometimes the first adjustment interval is longer or shorter than the following
intervals. For instance, an ARM's interest rate might not change for the first three
years, and then change once a year thereafter. Or the
initial rate might change after ten months rather than a year.
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The final feature common though all adjustable rate mortgages is the
initial interest rate. This is the rate that you pay until the end of the
first adjustment interval. The initial interest rate also determines the size of
your starting monthly payment. The initial interest rate for most ARM's is lower
than standard fixed rates.
Often the initial interest rate is lower than the sum of the current index value
plus margin. When it is several
percentage points lower, it is called a teaser rate. If your ARM starts with a teaser
rate, your interest rate and monthly payment will increase at the end of the first
adjustment interval unless your ARM's index goes down.
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Optional Features
Most ARMs have consumer protection options that limit the amount that your interest
rate and monthly payment can increase. They are called caps.
Periodic Interest Rate Cap
The first type of cap is the
periodic interest rate cap. It limits the amount
an ARM's interest rate can change from one adjustment interval to the next. If the
periodic interest rate cap is two percent, this means that the ARM's interest rate
cannot go up more than two percent. Without a periodic interest rate cap, the ARM's
rate could exceed that amount if the index moves more than the amount of the periodic
interest rate cap.
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Life Interest Rate Cap
The second type of cap that you want on an ARM is the life interest rate cap. It
sets the maximum interest rate that you can be charged for the life of the loan.
If the life interest rate cap is 12 percent and the
index value plus margin equals 13 percent, the life cap would limit the
rate increase to 12 percent. Even if the index went to 16 percent, as the One-Year
Treasury Bond Index did in 1982, the interest rate of this ARM would still be limited
to 12 percent.
Typically the life cap is quoted as percentage points over the initial interest
rate (i.e., a "six percent life interest rate cap" means five percent
over the initial rate).
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Initial Adjustment Rate Cap
If an ARM has an initial fixed period of more than one year a lender may provide
that the first adjustment exceed the periodic
interest rate cap. This means the initial adjustment could raise your interest
rate and payment substantially, but never more than the life interest rate cap.
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Conversion Option
This provides the borrower with the opportunity to convert their ARM rate to a fixed
rate during a specified time period. Typically, the borrower must have had the loan
for the fixed period of the loan plus one or more years. The conversion option also
provides for the fees to be paid and a rate formula to determine what the new fixed
rate will be. That rate may be higher than fixed rates available by refinancing
but it may eliminate other closing costs encountered with a
refinance.
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