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Fixed-rate versus adjustable rate mortgages

Fixed-Rate Versus Adjustable-Rate Mortgages: What You Should Know 
If you like choices, entering the housing market offers plenty of them. Even though inventory isn't quite as high as in previous years, nearly 2 million existing-homes up for sale is quite a few, according to the National Association of Realtors. Architectural home styles (e.g. Victorian, American colonial, ranch, contemporary, etc.) run the gamut as do mortgage types, including FHA loans, VA loans, conventional loans and more.

As it pertains to interest rates, though, it comes down to two: fixed versus adjustable. Each has its pluses, minuses and distinctions that make it different from the other. But don't let the binary nature of these fool you; there are a variety of considerations within each that you need to be mindful of to figure out which one is the better of the two for you.

If you're in the market to buy a house and hoping to take out a loan, here is a bit more on each that can help you decide the appropriate rate for your needs.

What is a fixed-rate mortgage?
As its title implies, a fixed-rate loan (FRM) includes interest rates that remain the same. This means that no matter how long you take out a mortgage for, the rate does not change from what it was when you initially applied for the mortgage. Due to market fluctuations, interest rates are subject to change on a fairly regular basis.

What makes FRMs worthwhile?
For many years, FRMs have been the most popular form of interest among mortgage borrowers. Part of the reason for this is they are inherently predictable. Generally speaking, people are creatures of habit. They appreciate the comfort in knowing what they can expect. This is particularly true as it pertains to finances. With an FRM, they can rest comfortable knowing that regardless of the rate environment, they'll pay the same interest rate for the life of their loan.

Currently, FRMs are quite low, especially when you compare them to where they once were in the 1970s and 1980s. In the late 1970s, rates were over 10% and even higher than that throughout much of the 1980s. Today, they average around 3.49% during the first week of September 2019, according to Freddie Mac. Last year during the corresponding period, they were 4.5%.

Of course, the amount of interest borrowers pay is determined on a case-by-case basis after your lender takes a look at your finances and credit history. 

What are the potential downsides of an FRM?
The main takeaway advantage of FRMs is they remain locked in. At the same time, though, the attractive element of FRMs can also be a detriment should rates lower. In other words, because they stay the same regardless of market forces, you could wind up spending more in interest compared to someone who takes out a loan later on if interest levels slip. 

What is an adjustable-rate mortgage?
On the opposite end of the interest type spectrum are loans with adjustable rates. This means that what you wind up spending in interest for however long you take out the mortgage for, will vary, perhaps even considerably. 

Much like FRMs, adjustable-rate mortgages (ARMs) are low historically speaking. As the most recent available data from Freddie Mac shows, a 5-year Treasury-indexed hybrid ARM averaged 3.30% for the week concluding Sept. 5. That's down from 3.93% 12 months earlier. 

Again, what you spend in interest may be different depending on your situation and when you decide to enter the housing market. It may also be influenced by the loan type you select.

What makes ARMs worthwhile?
The upside of ARMs is that, generally speaking, they usually start out with a lower interest rate, according to the Consumer Financial Protection Bureau. This can make them highly appealing to first-time homebuyers, who may not have as much money as they would like fresh out of college or starting a family. According to NAR data, first-time buyers represent approximately 33% of those who are looking to buy.

The low interest rate may remain the same for several months or perhaps even years. However, once the introductory period concludes, ARM borrowers frequently wind up spending more than they did originally, CFPB noted.

Take what is known as a 5/1 ARM as a classic example, yet another loan option of many that are offered by lenders these days. These products combine FRMs and ARMs by the rate staying locked in for the first five years. Thereafter, however, the rate is subject to change with each passing year until the loan is ultimately paid off completely. 

What are the potential downsides of an ARM?
Herein lies the rub with ARMs: They're inherently unpredictable. The amount you spend in interest in one year can be notably more than you pay 12 months later. This can present financial complications depending on your work situation and how you budget your money. At the same time, though, the difference in interest may not be all that significant at all, making the ARM potentially more worthwhile from a cost savings perspective than an FRM. 

When should you choose an FRM? An ARM?
While choices are nice to have, they, at the same time can be difficult to make. Selecting between an FRM and ARM is no exception. However, there are certain scenarios in which one may be more preferable than the other. Say you're in a comfortable situation with regard to work or home life and you don't expect any major changes in the foreseeable future. There's a certain comfort in this and can make choosing an FRM a smart move, especially if the locked-in rate is something that works for your budget. In short, if it ain't broke, don't fix it. 

As for when a variable rate may be more appropriate, consider how long you intend to stay in the home you plan on buying. Is this a house you see yourself living in long-term or is it more of a starter home? Perhaps you or your spouse are in the military, which would entail having to move to another state. In either of these situations, an ARM may be more appropriate because the way in which rates adjust can enable you to pay a lower interest rate early on.

If an adjustable-rate mortgage seems like the best choice, you may want to ask a few questions of your lender to get an idea of how the ARM changes over time. Here are a few of them, as suggested by the CFPB.

How soon will the rate change?
As we previously mentioned, exactly when an ARM adjusts varies from lender to lender. Much of this is dependent on the type of ARM you have. For example, a 5/1 ARM will stay the same for a longer period than will a 3/1 ARM, specifically for five years versus three. Both of these loan products are hybrid ARMs and may come in other durations (e.g. 7/1, 10/1, 15/15, etc.).

How high will rates go when they do adjust?
This is a particularly important question to ask, because what you spend for the first several years could be notably different than those following. Your mortgage provider will be able to tell you how high they'll go under the terms of the loan contract. There will be a cap, which will prevent the monthly mortgage payment from stretching your budget beyond its limit. 

Is refinancing a possibility?
Something that many people do to get a lower interest rate is taking advantage of refinancing. If you get to a point in which an ARM no longer makes sense. You may be able to switch to a fixed-rate loan. However, as CFPB cautions, don't select an ARM with the assumption that you'll be able to refinance. Even though it may be possible for you to do, market forces - as well as your own financial situation - is subject to change, which would make refinancing a move that's not in your best interest.

At Residential Mortgage Services (RMS), we know you have lots of questions about the homebuying process. We're here to offer answers in a clear, concise manner. Whether you're seriously thinking about entering the market or just want some basic information, don't hesitate to ask. We’ll guide you home.

Mortgage Speak

What does LTV stand for?

Jul 12
Category | Mortgage Speak

Rendering of a key that is separated out like a pie graph

What does LTV stand for?

You'll encounter many acronyms when you start speaking with mortgage and real estate professionals and it's easy to feel overwhelmed. Have no fear, we're here for you!

LTV stands for the Loan-to-Value ratio. What does that mean? LTV describes the loan amount as a percentage of the purchase price or value of the property.

Example time:

You're looking at a house that's perfect for you in every way. It's listed for $250,000. You've been saving up for this purchase and you have money set aside for a down payment and closing costs, plus hopefully a few extras. Working with your favorite loan officer, you're trying to figure out how much to put into the transaction so your monthly payment will be in that manageable sweet spot and you'll have a little left over to cover moving costs, furniture purchases and any unforseen needs. Closing costs (the amount of money you'll need to pay to cover the transaction, like transfer taxes and that kind of thing) can be estimated. The big question is, how much should the down payment be? You look at a few scenarios.

If you put 5% toward the home purchase, you'll be borrowing 95% of $250,000, which is $237,500. Said in another way, the loan ($237,500) to value ($250,000) would be 95%. Try saying that five times fast. Then you'll appreciate how easy it is to say, "95% LTV."

Wanted to look at a 20% down payment? That would be simplified to "80% LTV."

It's basically a quick way to say how much money is being borrowed without getting into specific dollar amounts. It works on refinances, too. Want to refinance your home so you're no longer paying monthly mortgage insurance? You might start talking to that favorite loan officer about mortgage loan programs at or under 80% LTV, since that's often the mark where mortgage insurance is no longer required.

See? It rolls off the tongue after you get used to it. Go ahead and try it out the next time you speak with your real estate agent or loan officer. It's an easy way to discuss your home financing options before getting too deep into exact dollar amounts, and it might just impress your friends.

Mortgage Speak

painting of a home surrounded by fields and mountains

What are USDA home loans, and do I qualify?

From interest rates and closing costs to credit history and insurance premiums, homeownership can appear daunting - especially if you operate on a fixed income. There are mortgage opportunities available, however, that can make the process of getting a loan and buying real estate easier and less intimidating.

It's called the Rural Development Guaranteed Loan Program. Backed by the U.S. Department of Agriculture, USDA home loans are geared toward borrowers with limited means and - as its title suggests - live in or hope to dwell in a rural location.

There are various definitions as to what "rural" actually means, but generally speaking, it refers to areas where the population is 35,000 people or fewer. So long as the property is within a USDA-RD designated rural area, you may be eligible for a USDA home loan.

There's an excellent chance the house you're considering falls within the USDA home loan footprint because rural climes cover approximately 97 percent of the nation's land area, according to the most recent estimates available from the U.S. Census Bureau.

Who qualifies for the USDA loan program?

It's difficult to say whether or not you'll qualify for this type of loan, mainly because lenders look at the whole package when determining approval. For example, they traditionally examine your income, debts, employment history and request a bank statement of available funds. Your debt-to-income ratio should be no higher than around 40 percent.

What credit score do you need for a USDA home loan?

Another core aspect of eligibility requirements is your credit history or credit score. Credit bureaus - Experian, TransUnion and Equifax - use credit scores to better analyze people's financial capabilities. Higher scores are the ideal and generally indicative of having paid bills off promptly and carrying manageable debt loads.

Much like qualifications, your credit score is evaluated in concert with other financial particulars, but most lenders require a FICO score of at least 640. The higher your score, the less you'll spend in interest should you be approved.

How does a USDA loan differ from a traditional mortgage?

For many years, a 20 percent down payment was standard operating procedure. That's no longer the case, as the National Association of Realtors says the average is around 5 percent for first-time home buyers. The down payment is perhaps the biggest distinction USDA home loans have compared to conventional - you don't need one at all.

There are a few other contrasts as well. One of which is the property must be owner-occupied so investment properties don't qualify. Also, your income can't be above a certain threshold, usually no more than 115 percent of the median income in your geographic area.

If you're looking to escape the city and enjoy the creature comforts from home on a budget, a USDA loan may be just the thing. Talk to your lender to find out more.

Mortgage Speak

Hand holding a money back passing to hand holding a toy house

What is an Earnest Money Deposit and why does it go into Escrow?

For that matter, what is escrow?

Let's start by defining "escrow." According to, escrow is a contract, deed, bond, or other written agreement deposited with a third person, by whom it is to be delivered to the grantee or promisee on the fulfillment of some condition.

When you make an Earnest Money Deposit, you probably want that money to go to a neutral third party, to make sure it's handled properly, right? That's where escrow comes in.

What is an Earnest Money Deposit?

When you agree to purchase a home, there is typically an "earnest money deposit" included in the agreement. This is money you put into the transaction in good faith. Should you walk away from the transaction, that money could be forfeited to the sellers. "So," you ask, "how does all of this work?"

Who, What, Where, When and Why

The journey to homeownership is made up of lots of different processes and "parties." The two most fundamental parties are, of course, the buyer and the seller. That's just the start of it, though. There are also the real estate agents, loan officers, underwriters and closers - all people you'll meet during the homebuying journey (although not necessarily in that order). A lesser known party is a third party - or what the industry sometimes refers to as an "escrow" officer. This can be an attorney, title company, etc. Each state has their own structure of how real estate transactions are settled. An escrow officer serves as a neutral third party when the homebuying process has actually reached the point of money changing hands.

Through an escrow officer - or the entity that serves this function - the home buyer makes an earnest payment that goes toward the purchase of the home. It's called "earnest" because it's an indication that the person buying the home is genuinely interested in buying a house that's for sale and is willing to part with something of value - cash - as a result. When the real estate transaction goes through successfully, the earnest money is generally counted toward the purchase of the home.

You may ask why that money doesn't go straight to the previous owner of the home. The main reason is that there are usually more things that have to happen before the deal is finalized. By holding the money in escrow - a limbo, of sorts - it provides both the seller and buyer with certain protections and assurances that the money will eventually change hands, but only after various terms and conditions are met, those which are generally mutually agreed upon.

In short, escrow officers - who could be an attorney or representative of a title company - serve as failsafes to assure that the actual purchase of the home goes as planned and that all sides are satisfied by the terms of the sales agreement. Alternatively, the money that's being held may return to you if the deal falls through because of the seller - like if the seller suddenly has a change of heart.

How much is an earnest money deposit?

That depends on you. The size of the earnest money deposit is part of the negotiation between the buyer and seller. The contract that's written up, often referred to as the "sales agreement," "purchase agreement" and "agreement of sale," details the terms of the earnest money deposit and how it may be drawn on, distributed or affected by unforseen events. It's a good idea to walk through the contract with your real estate agent and understand the ways your earnest money deposit could be affected.

See? Now you can swing these terms around with the best of them. Makes the whole process a little less intimidating, doesn't it? You've got this. And if you have questions, ask your favorite RMS loan officer.

Mortgage Speak

What does it mean to buy down a rate?

What does it mean to 'buy down' a mortgage rate?

When you apply for a mortgage and are in the market to buy a home for the first time, the terminology that's often used can sound like a foreign language. Lingo like “DTI" (debt-to-income ratio), "PITI" (principal, interest, taxes and insurance), "loan-to-value ratio," and "amortization schedules" can leave newbies scratching their heads.

While you don't always need to know all of the jargon, your comprehension of certain terms may help you save money. One such phrase to know is "buying down the rate." If you've heard of this before, mortgage points were the most likely subtext.

Otherwise and appropriately known as discount points, mortgage points are fees that come into play during the closing costs portion of a home sale transaction. In essence, mortgage points are upfront origination fees that allow you to "buy down" what you pay in interest over the length of your loan term, which is usually 15 to 30 years.

How much do mortgage points cost?

Generally speaking, one point is equal to 1 percent of the mortgage loan amount.  The more points you buy, the more you spend in origination fees at the closing table.

The upshot is that, by doing so, you may also wind up spending less over the life of your loan because the points you buy go toward reducing how much you spend in interest. You might think of buying down a rate as spending more now in order to save more money down the road.

Does it always make sense to buy down?

Here's the rub when it comes to mortgage buy-downs: They don't necessarily lead to cost savings. What's more, you may not have the available funds to lower your rate. In short, the effectiveness of this strategy varies on a case-by-case basis.

If you're house-hunting and want to get the most bang for your buck, talk to your mortgage loan officer about buying down your rate. Now that the phrase makes sense, your loan officer can help you determine if the strategy makes "cents."

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