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Current time:0:00Total duration:14:18

Video transcript

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 two hundred two hundred thousand dollars and I want to buy this house and I've saved up forty thousand dollars I have saved up forty thousand dollars so this is my savings and so I will use this as a down payment but I still need to borrow the rest of the money in order to get to two hundred thousand dollars so I'm going to have to get I am going to have to get the balance the hundred and sixty thousand dollars as as a loan as a loan and the type of loan that people get or that they usually get to buy a house is called a mortgage 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 when you pay off the loan it is your house to keep it 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 in all of these scenarios let's just assume that I'm in the market to borrow one hundred sixty thousand dollars for this house I'm about to buy so if you look at any financial website or any of the major even search 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 percent i mean these numbers a little bit simpler just 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'll cover in this video and hopefully they'll give you a sense of what the other types of mortgage is like a 30-year fixed mortgage means that your payment and your interest rate are fake just over 30 years and over the course of those 30 years you will pay off your loan so in this situation so let me so this is a 30 we write it over here so let's think about a 30 year fixed 30 year fixed mortgage what will happen is you will have a fixed pit you will have a fixed mortgage payment every month so and 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 is $2,000 I actually haven't figured out the math of what is the exact payment for a 30-year fixed with the 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 make it like this so this is $2,000 a month $2,000 this is month 1 then you will pay $2,000 in month 2 so on and so forth all the way if you have 30 years times 12 months you're going to get all the way to month 360 and you're going to and that is going to be your last payment month 360 is the last payment in year 30 and you would have paid off your loan the interesting thing here is in the first month since you've 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 do the interest in this magenta color so in that first payment 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 principal payment so let's say after that first month the principal 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 the interest portion is $1,800 I'm not actually working it through with these assumptions you don't even have to assume that it's $160,000 loan but the general idea here is after this first month you would have paid $200 off of your loan so if it was $160,000 loan after that first month you don't owe $160,000 - 2000 because 1800 of that was interest you now owe $160,000 - $200 so you now one hundred and fifty nine thousand one hundred fifty nine thousand eight hundred dollars and so in the next period your interest is going to be a little bit lower it's going to be just a little bit lower and your principal since you're staying the same fixed payment of two thousand dollars every month it's going to be a little bit higher maybe it's going to be in the next month something slightly higher I don't know two hundred and two dollars and you keep going like that and the math works out they figure out the payment so that by that last payment by that last payment you're paying very little interest you're paying very little interest and most of that last payment is principal it's actually being used for the loan and then after that last payment the loan is paid off and this will happen over thirty years this is a 30-year term a 15-year fixed is the same exact idea except instead of going from instead of this being instead of it taking 30 years to pay off the loan you're going to do it after over 15 years so instead of it being 360 months in the 15-year case it is going to be 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 a month maybe it is something like 2,800 2,800 dollars a month for the 15-year case you're paying it off quicker the 5/1 arm case and you'll see and there are many types of arms and I'm explained to you in a second one an arm is but the five one is the most typical and I'll explain what that means a second arm means arm means adjustable rate mortgage adjustable adjustable rate mortgage and as you see in in these situations we had the word fixed and they're they're called fixed because the interest rate was fixed whatever your whatever your remaining loan balance was you paid the same fixed amount of interest out for the next period so for this 30-year fixed we are being quoted a 5% fixed rate over the next 30 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 5-1 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 and will change according to some index the most typical types of adjustable rate mortgages are things like this hybrid arm so this is a hybrid and a hybrid it's viewed as a mixture of two things or a combination of two 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 it is a fixed rate for five years and then the interest rate can change once a year after that or every one years after that and that's what this right over here is telling you so the in case of in the case of an adjustable rate mortgage your payment might look something like this and I'll just make up numbers for simplicity just to give you the flavor what it might look like so months in the case of a 5-1 your first five years are fixed so your first five years so a month one it's going to look like that month two is going to look like that you go all the way to month sixty which is the last month in the five years and it's going to look like that so that's one that's month - that is month 60 this is the course of five years this is over the course of five years and over the course of five years its to sit the the idea is fairly similar you're going to pay some part of this is going to be 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 than interest when we get a little bit bigger and you're gonna have to pay a little bit less at interest and you're gonna have to pay a little bit less than interest because you've you have less remaining on your loan and by month but by by year five or month sixty you still haven't paid your loan off so maybe the interest is right over here maybe the interest is right over there it actually it'll probably be higher than that I don't want to be too exact but maybe your interest is going to be right over here and then and then this is what you're paying down from the loan for it a hybrid adjustable rate mortgage after that five 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 everyone is paying attention to and so if that underlying thing increases in interest so in this five in this five one arm it starts off at a three percent 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 then let's say they go up a lot then all of a sudden your payment could increase your payment could increase because the general idea behind a 5/1 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 if you just stick with this loan it will take you 30 years to pay it off but after the first five years the amount of interest you pay might actually change and so your payment might actually change so if the interest rate goes up 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 sixty one or in year six in year six in year six let me do that in I can do that that part of that same blue color and that for year six since this is a 5-1 arm they can't change the interest rate again until year seven so you'll pay this constant amount until year seven and then they can 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 six or your seven especially if interest rates go up a lot now you might be asking what Germans what that new interest rate is in after the five years and they usually pick some type of index the most typical are is especially the United States Treasury securities so they look at the 10-year Treasury interest rate that the essentially the government has to pay when it borrows money and they'll usually take some premium over this so if the one year or is the ten-year Treasuries at 2% the bank might put in your in your loan documents that after the initial five year fixed period you will pay a ten-year Treasury rate plus maybe you'll pay that plus one percent so you start off paying the three percent that's fixed even if the Treasury does all sorts of crazy things even if it goes up to five percent you're just going to keep paying the three percent for the first five years but then in that sixth year let's say that let me write it right over here let's say that in year six the Treasury the Treasury security rate now has bumped up to four percent then by contract by what's in your loan document you're going to have to pay that plus one percent so now your mortgage is going to reset to have a five percent rate have a higher rate you might get lucky though maybe you're maybe the Treasury rate goes down maybe it goes to one percent and then your mortgage rate would actually be one percent plus one percent so it could actually go down to two percent but the general idea is 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 you know 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 risks 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 down payment because they can get the house back and hopefully the house doesn't devalue by more than your down payment but even more than that there's an interest rate risk because what happens if the bank lends you money lends you a big chunk of money at 5% and that interest rates go up to 6% 7% what if they go up to 10% what the bank's borrowing cost the amount of money the bank has to pay people to borrow money goes up to ten percent then I'll be taking a loss on your loan so they and they're fixing it for so long that's why they want to make up for some of that risk by charging you higher interest a 15-year loan a little bit less risk so they'll have a little bit lower interest a 5/1 arm even lower risk they're only fixed for five years and then after that they can float this will float with the prevailing interest rate on an annual basis so hopefully that gives you a little bit of a primer of mortgage interest rates but I want to I want to really you know make sure that you don't view just this video is that all you need to take out a loan it's super important to read the fine details on on what's happening with that loan especially if you're buying something more if you're taking out a more exotic loan like an adjustable rate mortgage or an interest-only loan or an option an option arm or anything of those more exotic things