When shopping for the best mortgage, knowing the facts will help consumers obtain the right deal for their particular situation. A great place to start is by gaining an understanding of the differences between a fixed-rate and an adjustable-rate mortgage.
These are predictable mortgages with repayment terms usually stretching 15, 20 or 30 years. What makes them predictable? Both the interest rate and the monthly payments – for both the principal and interest portions of the payment – will remain fixed throughout the life of the loan.
Many consumers opt for a fixed-rate mortgage if they are purchasing a new home during a time when interest rates are low. Regardless, some people simply appreciate knowing what their monthly bill is going to be each month.
Adjustable-rate mortgage (ARM)
In comparison to fixed-rate mortgages, adjustable-rate mortgages usually start at a lower rate but that rate is not fixed. Instead, the rate, and therefore one’s monthly payment, is determined by changes in an index rate, such as the rate for Treasury securities or the Cost of Funds Index. When the index rate increases or decreases, so does the mortgage rate.
While signing an adjustable-rate mortgage agreement may seem like a gamble, these agreements normally include maximum and minimum rates. Also, recent new restrictions such as the Ability-to-Repay rule, which is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, are designed to help ensure that lenders only offer adjustable-rate mortgages to people who qualify, and not only based on consumers’ current income but on their assets as well.
Under the Ability-to-Repay rule financial institutions must follow these regulations:
- Potential borrowers have to supply financial information, and lenders must verify it.
- To qualify for a particular loan, a consumer has to have sufficient assets or income to pay back the loan.
- Lenders will have to determine the consumer’s ability to repay both the principal and the interest over the long-term − not just during an introductory period when the rate may be lower. This includes a requirement that lenders consider the loan’s “fully-indexed rate,” as opposed to just the initial rate.
According to MarketWatch.com, the fully-indexed rate is “the margin the lender has on that loan plus the index the loan is pegged to.”
According to the Consumer Financial Protection Bureau, the Ability-To-Repay rules are a nod to the American dream.
“Consumers should be able to trust the American dream of homeownership without worrying about losing the roofs over their heads and the shirts off their backs,” the Bureau states. “The Ability-to-Repay rule will help ensure that lenders and consumers share the same basic financial
incentives – that both of them win when borrowers can afford their loans.”