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Home equity loans have become a rage these days, since they give
ready access to loans at a cheaper rate and can be used for financing other
needs like buying a car or remodeling the existing house. Given the popularity
of these mortgage products, there are three main categories under which these
loans can be slotted:
Fixed Rate Mortgages: These loans have a fixed rate of interest over the
entire term for which the loan has been disbursed. The term for these mortgages
is typically between 10 to 30 years. The monthly interest payment on these loans
is fixed and hence there exists a certainty about the repayment of the debt over
the entire term of the debt. Another advantage of fixed rate mortgages is that
the initial down payment required is very low, generally around 5% of the loan
amount to be disbursed.
The disadvantage of this type of loan is that the rate of interest may be higher
than that of a variable rate mortgage. If predictability of the interest
payments is important, then it is advisable to consider securing a fixed rate
mortgage.
Adjustable Rate Mortgages (ARM): As the name indicates, the interest rate
on this type of mortgage fluctuates throughout the term of the loan depending on
the interest rate scenario in the economy. The rate for an ARM is usually
adjusted annually.
An ARM usually has caps, which restrict the rise in the rate to a certain level,
both on an annual basis as well as over the entire term of the loan. For
example, an ARM may have a cap of 1% every year and 5% over the term of the
loan. This type of loan is best if the term of the loan is short, as the longer
the term, the more the exposure to fluctuations in the interest rate. The index
to which the variable rate is pegged should also be carefully considered.
Thus a variable rate mortgage can work out to be a cheaper option than a fixed
rate mortgage, provided the borrower has given due attention to the risks
involved.
Jumbo Loans: If the equity loan to be raised exceeds the federal
guidelines set by Fannie Mae/Freddie Mac, then the loan is referred to as a
jumbo loan. The limit set by the guidelines is different from state to state.
The rates for jumbo loans are typically higher than those for other types of
mortgages, as the lender has a higher risk due to the larger amount of the loan.
The borrower should try not to exceed the guidelines, as this could mean a
considerable savings in terms of interest outflows. |
