Prepare and think ahead. 7-Year Fixed Rate Loan vs. 30-Year Fixed Rate Loan
What is the difference between a 7-year fixed rate loan vs. 30-year fixed rate loan? A 30-year fixed rate loan in real estate is a loan your bank loans you, which you agreed to pay back to them including principal and interest on the money you borrowed equally over a 360 months payment schedule (fully amortized).
In contrast, a 7-year fixed loan, which is also known as an ARM or adjustable rate mortgage, is repaid based on 30 years amortization schedule, including principal and interest that is usually at a lower rate than current fixed rate loans.
What happens at the end of the 7 years is your loan is “re-forecast” to include any unpaid principal and interest not paid over the past 7 years because of the low first interest rate. If interest rates have adjusted down, then your new re-forecasted ARM loan does too. If interest rates have gone up, your future interest rate will adjust with a higher interest rate along with higher monthly payments.
What determines your new rate is what your loan documents say. That was the “note” that you signed when you purchased your home initially. Usually the interest rate is tied to and index like the one-year Treasury Bills (T-Bills) index. Some loans are tied to the LIBOR index.
The T-Bill index moves slower than most indexes and the T-bill index moves down slower. LIBOR index reacts quickly where at times it may seem to move instantaneously. Depending on what is written in the terms of your loan both indexes may limit the amount loan payment can adjust. Usually the standard is around 2% or so.
When buying a 7-year Fixed Rate Loan make sure to understand adjustment periods and times making sure there is a cap on how high the loan interest rate could go. In the past, the standard cap for 7 year loans were 5% over the original note rate. This figure could change with the next inevitable increase in rates.
So why would anyone in their right mind want to buy a 7-year Fixed Rate Loan when they buy their new home? There are two very good reasons. 1.) 7-year fixed rate loans tend to have a lower interest rate than its counterpart the 30-year fixed rate loan. This means you can qualify for a higher priced home and maybe buy in a neighborhood more desirable to you. 2.) If you are planning to move or do a big remodel and then refinance your home again in under 18 months it makes sense to have the lowest interest rate possible for your brief use of the real estate loan.
As for the 30-year fixed rate loan you will need to be aware of any hidden clauses, which could not work in your best interest. For example, be sure to check out in your note for a prepayment penalty clause. Pre-payment clauses could add to your future expenses when you go to buy a new home. I have seen people have to pay 6 months mortgage payments as a penalty for repaying their loan before the time period was up.
If you would like to know more about what your real estate financing options are please feel free to contact me. My contact information listed in the signature below. Sign up for my Free Newsletter on the right side if you would like to receive more helpful information in the future. You may also search for any homes in the Greater Bay Area by using the “Quick Search” in the top right hand corner. Be sure to use the drop down arrow so you select your desired city.
Please comment below about what you think about these two types of loan products. A thumbs up or down would be a great second choice for you too. Thank you.