Interest Rates and Home Loans

By: Martin Lukac

Once you have taken on a home loan your monthly payment starts from the following month. A monthly payment of a home loan depends on the total amount of money that you have borrowed, the number of years or months you have to pay off the loan and the interest rate of the mortgage.

There are various types of interest rates offered by different institutions. Normally, there are Interest Only Rate, Adjustable Rate, and Fixed Rate. Adjustable Rate and Fixed Rate carry two more sub divisions in few institutions with the purpose of the borrowing. For example, there can be - Adjustable Rate Residential Home Loans, Fixed Rate Residential Home Loans, Adjustable Rate Investment Home Loans and Fixed Rate Investment Home Loans.

Though they vary from institution to institution, there are some basic features which are common to all home loans offered -

(i)Interest Only Rate: Here an interest only payment option is attached with the contract note. You have to pay only the interest on the mortgage in the noted fixed period of time.

For example, suppose you have taken a 5 years' interest only home loan. Then the payable interest will be the current interest rate with the margin rate as decided, say of 2.25%. You will be paying this amount for five years. After that time you have to pay the adjusted interest only mortgage rate with the principal amount you borrowed at monthly basis.

Typical interest only rates are short term. This type of rate is most suitable for individuals in high-income brackets, for young professionals who may have a lower income with a prospect of better income in near future, for short term home owners and for investors in property.

(ii)Adjustable Rate: Here the interest rate is not fixed. The interest rate depends on various indexes. Different lenders establish different indexes. Some common indexes are - treasury notes and bills, the Housing Finance Boards' national average, average interest rate paid on certificates for deposit, costs of funds for the lender etc.

This type of interest rate can increase or decrease depending on the market. With low market rate, your monthly payment will be less. Qualify for this type of Home Loan is easier.

Initial low rate interest is a special benefit from this type. However, initial rates, margins, adjustment intervals, rate caps and payment caps also characterize the adjustable rate.

(iii)Fixed Rate: Here the interest rate is fixed for the whole duration of the loan. It is the most popular type. 75% of home loans come in this type. Being a fixed rate, it stabilizes your monthly expenditure.

For example, suppose you earned a home loan to be paid over 15 years with 6% fixed interest rate. The market rate can increase or decrease, but in this case, you will be paying 6% interest rate all through the years.

Naturally, it provides better security to the borrower. But the fixed rate charge is higher than the adjustable rates. Also its initial monthly payment is higher than the other. It is most suitable for the first time borrowers, for people with moderate or low income.

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