Mortgage

A legal agreement by which a bank, building society, etc. lends money at interest in exchange
for taking title of the debtor's property, with the condition that the conveyance of title
becomes void upon the payment of the debt.

1. Fixed Rate Mortgage

2. Adjustable-rate Mortgage (ARM)
3. Variable rate Mortgage
4. Interest only Mortgage
5. Discount Mortgage
6. Offset Mortgage

Fixed-Rate Mortgage

A fixed-rate mortgage is a home loan with a fixed interest rate for the entire term of the loan.

 Once locked-in, the interest rate does not fluctuate with market conditions.
 Borrowers who want predictability and those who tend to hold property for the long
term tend to prefer fixed-rate mortgages.
 Most fixed-rate mortgages are amortized loans.
 In contrast to fixed-rate mortgages, there exist adjustable-rate mortgages, whose
interest rates change over the course of the loan.

Most mortgagors who purchase a home for the long term end up locking in an interest
rate with a fixed mortgage. They prefer these mortgage products because they're more
predictable. In short, borrowers know how much they'll be expected to pay each month so
there are no surprises.

Unlike variable and adjustable-rate mortgages, fixed-rate mortgages don't fluctuate with
the market. So the interest rate in a fixed-rate mortgage stays the same regardless of where
interest rates go—up or down.
The amount of interest borrowers pay with fixed-rate mortgages varies based on how long
they're amortized. Mortgagors pay more in interest in the initial stages of repayment. More
money is applied toward the principal later on. So someone with a 15-year term will pay less in
interest than someone with a 30-year fixed-rate mortgage.

Adjustable-Rate Mortgage (ARM)

An adjustable-rate mortgage (ARM) is a type of mortgage in which the interest rate

applied on the outstanding balance varies throughout the life of the loan. With an adjustable-
rate mortgage, the initial interest rate is fixed for a period of time. After this initial period of
time, the interest rate resets periodically, at yearly or even monthly intervals. ARMs are also
called variable-rate mortgages or floating mortgages. The interest rate for ARMs is reset based
on a benchmark or index, plus an additional spread called an ARM margin.

An ARM can be a smart financial choice for home buyers that are planning to pay off the
loan in full within a specific amount of time or those who will not be financially hurt when the
rate adjusts.

Example:

Typically an ARM is expressed as two numbers. In most cases, the first number indicates the
length of time the fixed-rate is applied to the loan.

For example, a 2/28 ARM features a fixed rate for two years followed by a floating rate for the
remaining 28 years. In contrast, a 5/1 ARM boasts a fixed rate for five years, followed by a
variable rate that adjusts every year (as indicated by the number one). Similarly, a 5/5 ARM
starts with a fixed rate for five years and then adjusts every five years.

Variable Rate Mortgage

A variable rate mortgage is a type of home loan in which the interest rate is not fixed. Instead,
interest payments will be adjusted at a level above a specific benchmark or reference rate, such
as the Karachi Interbank Offered Rate (KIBOR) + 2 points. Lenders can offer borrowers variable
rate interest over the life of a mortgage loan. They can also offer a hybrid adjustable-rate
mortgage (ARM), which includes both an initial fixed period followed by a variable rate that
resets periodically thereafter.

Example:

Adjustable rate mortgage loans (ARMs) are a common type of variable rate mortgage loan
product offered by mortgage lenders. These loans charge a borrower a fixed interest rate in the
first few years of the loan followed by a variable interest rate after that.

The terms of the loan will vary by particular product offering. For example, in a 2/28 ARM loan,
a borrower would pay two years of fixed rate interest followed by 28 years of variable interest
that can change at any time.

In a 5/1 ARM loan, the borrower would pay fixed rate interest for the first five years with
variable rate interest after that, while in a 5/1 variable rate loan, the borrower’s variable rate
interest would reset every year based on the fully indexed rate at the time of the reset date.

Interest-Only Mortgage

An interest-only mortgage is a type of mortgage in which the mortgagor (the borrower) is

required to pay only the interest on the loan for a certain period. The principal is repaid either
in a lump sum at a specified date, or in subsequent payments.

Interest-only payments may be made for a specified time period, may be given as an option, or
may last throughout the duration of the loan (mandating you pay it all back at the end). Usually,
interest-only loans are structured as a particular type of adjustable-rate mortgage. While
interest-only mortgages mean lower payments for a while, they also mean you aren't building
up equity, and mean a big jump in payments when the interest-only period ends.

Usually, interest-only loans are structured as a particular type of adjustable-rate

mortgage (ARM), known as an interest-only ARM. You pay just the interest, at a fixed rate, for a
certain number of years, known as the introductory period. After the introductory period ends,
the borrower starts repaying both principal and interest, and the interest rate will start to vary.
For example, if you take out a "7/1 ARM", it means your introductory period of interest-only
payments lasts seven years, and then your interest rate will adjust once a year.

Paying Off the Interest-Only Mortgage

At the end of the interest-only mortgage term, the borrower has a few options. Some
borrowers may choose to refinance their loan after the interest-only term has expired, which
can provide for new terms and potentially lower interest payments with the principal. Other
borrowers may choose to sell the home they mortgaged to pay off the loan. Still other
borrowers may opt to make a one-time lump sum payment when the loan is due—having saved
up by not paying the principal all those years.

Discount Mortgage

Discount mortgage are a type of prepaid interest or fee that mortgage borrowers can purchase
that will lower the amount of interest they have to pay on subsequent payments. Each discount
point generally costs 1% of the total loan amount and depending on the borrower, each point
lowers the loan's interest rate by one-eighth to one one-quarter of a percent. Discount points
are tax-deductible only for the year in which they were paid. Discount points are a good option
if a borrower intends to hold a loan for a long period of time, but less useful if a borrower
intends to sell their property or refinance before they are able to break even on the extra
upfront payment.

Discount points are also known as mortgage points. They are a one-time, upfront mortgage
closing cost that gives a mortgage borrower access to discounted mortgage rates as compared
to the market. Because the Internal Revenue Service (IRS) considers discount points to be
prepaid mortgage interest, they are tax-deductible only for the year in which they were paid.1

Example:

For example, on a $200,000 loan, each point would cost $2,000. Assuming the interest rate on
the mortgage is 5% and each point lowers the interest rate by 0.25%, buying two points costs
$4,000 and results in an interest rate of 4.50%. Depending on the length of the mortgage at this
interest rate, this could result in significant savings over time. This would ideally be suited for a
fixed-rate 30-year mortgage that most likely wasn't going to be refinanced anytime soon.

Offset Mortgage

An offset mortgage is a type of home loan that involves blending a traditional mortgage with

one or more deposit accounts held by the same financial institution. The savings balance
maintained in the deposit account may then be used to offset the mortgage balance,
lowering interest payments due.

An offset mortgage is an attractive option for paying back a mortgage loan primarily because
the borrower can make small payments to pay down the principal instead of the interest.

Example:

The Smith family has an offset mortgage. The principal is $225,000 with a 5% interest rate, and
the family has $15,000 held in savings with the same lender with no withdrawals during the last
month. Calculation of the next interest payment on an offset loan would be based on the
$210,000 balance, which reflects the loan principal less the savings account balance: ($225,000
– $15,000 = $210,000).