University of Hawaii FCU 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 | Balloon | ARMs
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, 20-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 or 20-year fixed term and 30-year fixed term
Balloons are short-term mortgages that contain features similar to fixed rate mortgages. Typically, the Balloon is a short-term loan, however, the monthly payments are calculated using a 30-year term. Such payments remain unchanged for a predetermined period, at the end of which, a lump sum payment is due to pay off the remaining principal balance of the loan. This larger payment is the balloon payment.
In general, borrowers sell or refinance before their balloons are due.
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:
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.
Optional Features
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
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.
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.
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.
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).Initial Adjustment Rate Cap.
Initial Rate
