Purchase Money Mortgages: How Do They Work?
When you are looking to purchase a house and get a mortgage you are agreeing to repay a borrowed amount of money to a lender in a certain amount of time. You are also subject to paying a little more than the original loan amount, which is called, interest. In most cases, you are choosing between two mortgage types. One being a fixed-rate mortgage and the other being an Adjustable-Rate Mortgage also referred to as an ARM, this is the one we are talking about today.
With this new market ahead of us Adjustable-Rate Mortgages are becoming increasingly more popular. Why is that? Because with the recent rise in Interest Rates ARMs can be less expensive in the short run. Let’s break it down:
How do they work?
ARMs begin with an interest rate that is typically below the market rate on comparable fixed-rate mortgages. This low rate does not last forever though, it may last months or years but after the initial period, the rate will re-adjust on a schedule.
You will see ARMs written as, 5/1 or 5/3 ARM, this means the loans have a fixed interest rate for the first 5 years. Your lender will offer multiple time frame options. The most common ARM term will have an initial period of 3, 5, or 10 years. Once that time has passed the rate can change once a year or every 3 months.
What does this mean?
This means that while interest rates are higher you will have a lower rate with an Adjustable-Rate Mortgage, allowing you to have a lower monthly payment and potentially afford more home as well. You also will have the opportunity to watch the market and may find a good time to refinance in the future.
Other reasons for ARM?
Another great reason to choose this type of loan is if you plan to move quickly after the purchase. Maybe you are planning to sell the home, relocating, or refinancing soon. These are all reasons that might make an ARM loan an excellent option for you!
Things to look out for?
ARM loans can be unpredictable after your fixed term. Your future financial situation will determine your next steps. For example, if you try to refinance at the end of your initial period, you may not qualify for a better loan, making you stuck with your current mortgage and the adjusting rate. Also, keep in mind that some ARM loans will have a Pre-Payment Penalty, this is to protect the bank from the loss of interest income that would otherwise have been paid overtime. Remember they are offering a lower rate upfront, and they need to protect the investment. Do not fear though because there are many lenders who do not have a Pre-Payment Penalty.
At the end of the day, you want to make sure you make the decision that is best for your situation and reaching out to a professional is the first step.
Vanguard Can Help!
At Vanguard, we are here to guide you! We know that buying a home is one of the most important and complex decisions you’ll ever make. We explain everything at the start of the closing process to minimize any confusion and prevent any surprises along the way. From beginning to end, we keep all parties involved in each transaction informed and updated. And we’re committed to making sure that your overall experience is a positive one. If you are in need of a lending professional to determine your next steps, let us know, we have wonderful clients that can help you along the way.