Mortgage
If you are looking for a home loan for yourself, you may be a little bit confused and bewildered by the seemingly endless variety of home loans that are available. Here is your basic guide to the different types and the pros and cons of each:
Fixed-rate mortgages. In a fixed-rate mortgage, the interest rate and therefore the monthly payment remain fixed throughout the term or tenure of the loan. The advantage is that you know exactly what you are committed to financially and you will get peace of mind because your monthly payment is not dependent on the vagaries of the market. The bulk of the mortgages in the United States, for instance, are fixed-rate mortgages. In Singapore, the fixed-rate is generally applicable for a period of 1 to 3 years and the disadvantage is that you are locked in for this period of time. Generally speaking, fixed-rate mortgages tend to be more expensive than variable-rate mortgages, especially in an environment where interest rates are low.
Variable rate mortgages. Also known as adjustable rate mortgages, the interest rate is adjusted at periodical intervals on the basis of a specified index or benchmark. With variable-rate mortgages, the mortgage lender tries to transfer some of the interest rate risk to the borrower and these mortgages therefore tend to be cheaper than fixed-rate mortgages. For instance, if your variable-rate mortgage is based on the London interbank offered rate (LIBOR) and your terms are LIBOR +2%, you will pay 4% as interest is LIBOR is 2% when your interest rate is being set. The disadvantage is that you will never know with certainty what your monthly repayment liability is over the tenure of the loan. Of course, you could benefit under favorable interest rate conditions.
The above mortgages are often referred to as capital and interest mortgages because over the life of the loan, you repay both principal and interest in the process called amortization. Every monthly repayment that you make will have an element of both interest and principal though the exact terms will depend on the country of your residence. For example, interest may be charged on the basis of a 360 day “year” for interest may be compounded at differing intervals such as quarterly or half yearly. However, it is possible to have home loans with differing capital and interest plans.
Interest only mortgages. These mortgages only require the payment of interest with no repayment of capital during the life of the mortgage. These mortgages are popular in the UK where they operate in conjunction with an investment plan. Instead of making a principal repayment on the mortgage, the borrower pays a fixed amount into an investment plan so that money is available to pay off the mortgage at the end of the stipulated tenure. These mortgages can also come in useful when you do not intend to stay in a home for a long period of time and wish to limit your financial outflow.
Reverse mortgages. These are mortgages in which there is no repayment of either principal or interest during the tenure of the mortgage. Typically, this is used by elderly people and amounts to unlocking their equity in their homes during their lifetime. The mortgage principal and accumulated interest is normally repaid by the sale of the property on the death of the owner.
