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| What is the difference
between fixed rate and variable rate mortgages?
A fixed rate
mortgage is a loan where the principle and interest payment never change during
the life of the loan.
A variable rate mortgage is a loan where the
interest rate can change periodically. The changes in the interest rate are tied
into the market rates that exist at the time the rate is subject to change. They
usually offer lower interest rates than fixed rate mortgages, but can adjust
upward if interest rates go up. There is a predefined cap which defines how high
the interest rate can adjust.
Fixed rate mortgages are beneficial to
those who are on a fixed income, (adverse to interest rate change) and those who
prefer fixed payment schedules.
Adjustable rate mortgages are
advantageous for those who do not plan to stay in their home for a long time,
for those borrowers who do not qualify at higher fixed interest rates, and those
who can financially handle fluctuating payments.
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| How do adjustable rate
mortgages work?
There are
many types of adjustable rate mortgages, but all have some common features.
One common feature of adjustable rate mortgages is an interest rate
change that occurs after a stipulated number of payments have been made. The
interest rate can increase or decrease depending on how the new interest rate is
calculated. Typically, the interest rate change is based upon a predetermined
index value and a margin. If a mortgagor currently has an interest rate that is
pending adjustment, the new rate would be calculated by adding the current index
rate and a margin. For example, if the mortgagor’s current rate was 6.000% with
a 2.000% margin, the new rate would be determined by adding the current index
rate (5.000% as an example) to the margin. In this example the new interest rate
would be 7.000%.
The maximum amount the interest rate
can change during any adjustment period is usually fixed. This maximum
adjustment is called the cap. Adjustable rate mortgages also have a lifetime
cap, preventing the interest rate from exceeding a predetermined
rate.
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| What are escrow
accounts and how much do I need in my escrow account?
Escrows are
payments made by a mortgagor to a mortgagee for the purpose of paying the
mortgagor’s taxes, insurance, and other payments associated with home ownership.
The mortgagee is responsible for the timely disbursement of escrow funds to pay
the mortgagor’s bills as they come due.
Usually, a mortgage company
collects funds for placement into the mortgagor’s escrow account with the
mortgagor’s periodic payment for principal and interest. An escrow account has
sufficient funds if there is enough to pay all bills when they come
due.
It is common practice for mortgage companies to
hold an escrow cushion for a mortgagor. The cushion is kept by the mortgage
company to assure that if the cost of any escrowed item were to increase in the
future, there would be sufficient funds to pay all bills as they come
due.
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Susan Hanning-Pace
