Mortgages
Mortgage Interest Rates Understanding how mortgage interest rates are quoted
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- When most people buy a house
- they need to borrow money for some part
- of the purchase price of the house.
- So let's say that we have a house right over here
- and the purchase price is $200,000
- And I want to buy this house
- and I've saved up $40,000.
- So this is my savings, and so I will use this as a downpayment
- but I still need to borrow the rest of the money
- in order to get to $200,000.
- So I'm going to have to get the balance,
- the $160,000 as a loan.
- And the type of loan people get
- or they usually get, is called a mortgage.
- And a mortgage is really just a loan
- where if you don't pay the loan off,
- the person that you borrowed the money from
- gets the house. So another way to think about it is
- it's a loan that is secured by the house until you
- pay off the loan. And when you pay off the loan,
- it is your house to keep. But at any point,
- if you don't pay it, the bank can come and take the house
- and that is called a foreclosure.
- Now what I want to focus on in this video
- is the types of mortgage loans you will typically see,
- and give you at least the beginning of an understanding
- of how to understand what these different types of loans mean.
- So all of these scenarios, let's just assume
- that I'm in the market to borrow $160,000
- for this house that I'm about to buy.
- So if you look at any financial website, or any of the major
- web portals, they'll give you quotes for mortgage rates
- and you'll see something like this.
- I made these numbers really simple, normally you'll have some decimals here
- 5.25%, 4.18%, I made these numbers a little bit simpler
- just to make them simpler.
- So, these are the typical types of mortgages you will see
- but if you contact a mortgage broker, they'll
- have many, many more types, more exotic types,
- but these are the most common
- this is what we will cover in this video,
- and hopefully this will give you a sense of what the other types
- of mortgages are like.
- A 30-year fixed mortgage means that your
- payment and your interest rate are fixed over 30 years,
- and over the course of those 30 years,
- you will pay off your loan.
- So in this situation, so this is a 30... let me write it over here
- So let's think about a 30 year fixed mortgage.
- What will happen is you will have a fixed mortgage
- payment every month. I'll draw a little bar graph
- to show the size of your payment.
- You'll see why I'm doing that in a second.
- So let me just draw a little bit of a graph here.
- So each of these blocks represent your
- monthly payment for that month
- and I'm just going to make up the number
- let's say it's $2,000. I actually haven't
- figured out the math of what is the exact payment
- for a 30-year fixed with a 5% interest rate
- for $160,000. But let's just say
- for the sake of simplicity, let's say it's $2,000 a month.
- So this height right over here
- let me make it like this
- So this is $2,000 a month.
- $2,000. This is month one, then you will pay
- $2,000 in month 2, and so on a so forth,
- all the way... if you have 30 years times 12 months
- you're gonna get all the way to month 360, and
- that is going to be your last payment.
- Month 360 is the last payment in the year 30,
- and you would have paid off your loan.
- The interesting thing here is, in the first month
- since you have borrowed so much from the bank
- you've borrowed $160,000. The interest that you have to pay on it
- is going to be pretty large.
- So most of the initial payments
- are going to be interest.
- So I'm going to the interest in this magenta color
- That's not magenta... this is magenta.
- In that first payment, it's going to be mostly interest.
- And you're going to pay a little bit off of the actual loan,
- so that right there is your principle payment.
- So let's say after that first month, the principle part
- of that $2,000 is (and I'm just making up numbers for the sake of simplicity),
- Let's say that that is $200, and the interest portion
- is $1,800. I'm not actually working it through
- with the assumptions. You don't even have to assume
- that's a $160,000 loan. But the general idea
- here is that after this first month, you would have
- paid $200 off of your loan. So if it was a $160,000 loan
- after that first month, you don't owe $160,000 minus $2,000
- because $1,800 of that was interest. You now owe
- $160,000 minus $200, so you now owe
- $159,800.
- And so in the next period,
- your interest is going to be just a little bit lower.
- And your principle, since you're paying the same fixed payment
- of $2,000 every month, is going to be a little bit higher.
- Maybe it's going to be the next month something slightly higher
- I don't know, something like $202, I don't know...
- And you keep going like that
- and the math works out, they you figure out the payment
- so that by that last payment
- you're paying very little interest,
- and most of that last payment is principle.
- it's actually being used for the loan.
- And then after that last payment
- the loan is paid off. And this will happen
- over 30 years. This is a 30 year term.
- A 15-year fixed is the same exact idea
- except, instead of it taking 30 years to pay off the loan
- you're going to do it over 15 years
- so it instead of it being 360 months in the 30 year case
- it is going to be 180 months
- and because of that your payment for the same loan amount
- is going to be higher every month
- because you're paying it off quicker
- you're paying it off in fewer months.
- Instead of $2,000 per month, maybe it is something like
- $2,800 a month for the 15 year case.
- You're paying it off quicker.
- The five one ARM case, you'll see there are many types of ARMs,
- and I'm gonna explain to you in a second what an ARM is
- but the five-one is the most typical
- and I will explain that in a second.
- ARM means Adjustable Rate Mortgage.
- And as you see in these situations,
- we have the word "fixed," and they're called fixed
- because the interest rate was fixed.
- Whatever your remaining loan balance was,
- you paid the same fixed amount of interest for the next period
- so for this 30 year fixed, we are being quoted
- a 5% fixed rate over the next years (will not change),
- for the 15 year, we're quoted a 4% fixed rate
- for the ARM, the rate can change.
- When someone tells you about a five-one ARM
- They're actually talking about something called
- a hybrid ARM, but the general idea behind an adjustable rate mortgage
- is the amount of interest you pay on your remaining balance
- will change according to some index.
- The most typical types of adjustable rate mortgages
- are things like this hybrid ARM.
- This is a hybrid. And a hybrid, it's viewed as a mixture
- of two things, or a combination of 2 things
- and what a hybrid adjustable rate mortgage is
- is it has a fixed rate for some period of time
- in this case it's a fixed rate for 5 years.
- and then the interest rate can change
- once a year after that, or every 1 years after that
- And that's what this right over here is telling you
- So in the case of an adjustable rate mortgage,
- your payment might look something like this
- I'll just make up numbers for simplicity
- just to give you a flavor of what it might look like.
- So in the case of a five-one, your first five years
- are fixed. So month 1 can look like that,
- month 2 is going to look like that
- you go all the way to month 60, which is the last month
- of 5 years. So that's month 1, that's month 2, that is month 60
- This is over the course of 5 years
- And over the course of 5 years, the idea
- is fairly similar. Some part of this is going to be
- interest, and the remainder is going to actually be used
- to pay down the loan. And each month you're going to
- pay down a little bit more of the loan
- and you're going to have to pay a little less in interest
- because you have less remaining on your loan.
- But by year 5, or month 60, you still haven't paid your loan off
- So maybe the interest is right over here,
- Maybe the interest is right over there
- and actually it may be higher than that
- I don't want to be too exact
- and then this is what you're paying down from the loan
- A hybrid adjustable rate mortgage, after that 5 year period
- The bank can now change the interest rate
- And the interest rate is going to be dependent
- on some kind of underlying thing that every one is
- paying attention to. And so if that underlying thing
- increases in interest. So in this five-one ARM
- it starts off at a 3% interest. If because of this thing
- that we're paying attention to
- and I'll talk more about that in a second
- interest rates all of a sudden go up
- and let's say they go up a lot
- then all of a sudden your payment could increase.
- Because the general idea behind a five-one ARM
- is that you are still going to pay it off
- in 30 years. So they typically, I should say,
- have a 30 year term. So if you just stick with this loan
- you never try to borrow other money to replace this loan
- which is called a refinance
- you stick with this loan, it will take you 30 years
- to pay it off. But after the first 5 years
- The amount of interest you pay might actually change
- So your payment might actually change.
- So if the interest rate goes up
- All of a sudden, you might have to pay
- a lot more interest
- all of a sudden in month 61, or in year 6.
- Let me do that part in that same blue color
- And that for year 6, since this is a five-one ARM
- They can't change the interest rate again until
- year 7, so you'll pay this constant amount
- until year 7. But then they will change the rate again.
- And there usually are some caps on how much they can change the rate
- each year or how much they can change the rate in total
- but it is a little bit riskier
- because you really don't know what your payment might be
- in year 6 or 7, especially if interest rates go up a lot
- Now you might be asking,
- "What determines what that new interest rate is after the 5 years?"
- And they usually pick some type of index
- the most typical are treasury securities
- so they'll look at the 10-year treasury interest rate
- that essentially the government has to pay when it borrows money
- and they'll usually take some premium over this
- So if the 10-year treasuries are at 2%
- The bank might put in your loan documents
- that after the initial 5 year fixed period
- you will pay 10-year treasury rate, plus 1%.
- So you start off paying the 3%, that's fixed
- even if the treasury does all sorts of crazy things
- even if it goes up to 5%, you're just going to
- keep paying the 3% for the first 5 years
- but then in that 6th year
- let's say that (let me just write it over here)
- let's say that in year 6 the treasury security rate
- now has bumped up to 4%
- then by contract, by what's in your loan document
- you're going to have to pay that, plus 1%
- so now your mortgage is going to reset
- to have a 5% rate, have a higher rate.
- You might get lucky though
- maybe the treasury rate goes down
- maybe it goes to 1%, and then your mortgage rate would actually be 1% plus 1%
- so it could actually go down to 2%
- But the general idea is that that's a little riskier
- because you really don't know how predictable that payment
- is going to be.
- And if you look at most times
- if you look at quoted interest rates
- you'll see that the 30-year fixed rate is higher
- than the 15-year fixed rate, which is higher than
- the adjustable rate. And that's because the bank,
- there's a couple of different forms of risk
- but the bank is taking the least amount of risk
- on the adjustable rate mortgage
- and taking the most amount of risk on the 30 year fixed.
- And the biggest risk here, there's the risk that you don't pay it off
- But that's why they like to see a downpayment
- because they can get the house back and hopefully
- the house doesn't devalue by more than the amount
- of your down payment. But even more than that
- there's an interest rate risk.
- What happens if the bank lends you money
- lends you a big chunk of money at 5%
- and then interest rates go up to 6%, 7%
- what if they go up to 10%? What if the banks borrowing costs,
- the amount of money the bank has to pay people to borrow money,
- goes up to 10%, then they will be taking a loss on your loan
- They're fixing it for so long, that's why they want to
- make up for some of that risk by charging you
- higher risk.
- A 15 year loan, a little bit less risk
- so they'll have a little bit lower interest.
- A five-one ARM, even lower risk
- they're only fixed for 5 years
- and then after that, this will float with the prevailing interest rate
- on an annual basis.
- So hopefully that give you a little bit of a primer
- of mortgage interest rates
- but I want to really make sure you don't view this video
- as all you need to take out a loan.
- It's super important to read the fine print and details
- on what's happening with that loan,
- especially if you're buying something more, if you're taking out a more exotic
- like an adjustable rate mortgage
- or an interest only loan, or an option ARM
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