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  • Narrator: When most people buy a house they need

  • to borrow money for some part of the purchase price of the house.

  • 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.

  • I have saved up $40,000, so this is my savings,

  • 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 $200,000.

  • I'm going to have to get the balance, the $160,000 as a loan.

  • The type of loan that people that people will get,

  • or that they usually get to buy a house is called a mortgage.

  • Mortgage. 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.

  • Another way to think about it is it's a loan

  • that's secured by the house until you pay off the loan.

  • When you pay off the loan it is your house to keep,

  • but at any point if you don't pay it,

  • the bank could 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.

  • In all of these scenarios, let's just assume

  • that I'm in the market to borrow $160,000

  • for this house I'm about to buy.

  • If you look at any financial website or any

  • of the major search-web portals,

  • they'll give you quotes for mortgage rates.

  • 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.

  • These are the typical types of mortgage you will see,

  • but if you contact mortgage broker they will have

  • many, many more types, more exotic types;

  • but these are the most common

  • and this is what we'll cover in this video.

  • 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 fixed over 30 years,

  • and over the course of those 30 years you will pay off your loan.

  • In this situation, this is a 30 ...

  • Let me write it over here, let's think about a 30 year fixed.

  • 30 year fixed mortgage. What will happen is you

  • will have a fixed mortgage payment every month,

  • 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.

  • Let me just draw a little bit of a graph here.

  • 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 a 5% interest rate for $160,000;

  • but, let's just say, for the sake of simplicity, it's $2,000 a month.

  • This height right over here, let me make it like this.

  • 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 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.

  • Most of the initial payments are going to be interest.

  • I'm going to do the interest in this magenta color.

  • In that first payment. Oh, that's not magenta. This is magenta.

  • In that first payment it's going to be mostly interest.

  • You're going to pay a little bit off of the actual loan;

  • so that right there is your principle payment.

  • 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 is $200,

  • and the interest portion is $1,800.

  • I'm not actually working it through with these assumptions.

  • You don't even have to assume that's a $160,000 loan,

  • but the general idea here is after this first month

  • you would have paid $200 off of your loan.

  • If it was $160,000 loan, after that fist 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.

  • 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 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, in the next month,

  • something slightly higher; I don't know, $202.

  • You keep going like that and the math works out;

  • they figure out the payment so that by that last

  • payment you're paying very little interest,

  • 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.

  • 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.

  • Instead of it being 360 months,

  • in the 15 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 a month, maybe it is something

  • like $2,800 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 going to explain to you in a second what an ARM is,

  • but the 5/1 is the most typical.

  • I'll explain what that means in a second.

  • ARM means 'Adjustable Rate Mortgage.'

  • Adjdustable

  • Rate

  • Mortgage

  • As you see, in these situations we had

  • the word 'fixed,' and they were 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.

  • 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.

  • It 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.

  • A hybrid, it's viewed as a mixture of 2 things,

  • or a combination of 2 things.

  • What a hybrid adjustable rate mortgage is

  • it has fixed rate for some period of time.

  • In this case, it's a fixed rate for 5 years,

  • then the interest rate can change once a year

  • after that, or every 1 years after that.

  • That's what this right over here is telling you.

  • 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 of what it might look like.

  • In the case of a 5/1, your first 5 years are fixed.

  • Your first 5 years. Month 1 is going to look like that.

  • Month 2 is going to look like that.

  • You go all the way to month 60,

  • which is the last month in the 5 years

  • and it's going to look like that.

  • That's 1, that's month 2, that is month 60.

  • This is the course of 5 years.

  • This is over the course of 5 years.

  • Over the course of 5 years, the idea is fairly similar.

  • You're going to pay, some part of this is going

  • to be interest, and the remainder is going

  • to actually be used to pay down the loan.

  • 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.

  • Make that a little bit bigger.

  • You're going to have to pay a little bit less interest,

  • because you have less remaining on your loan,

  • but by year 5, or month 60, you still haven't paid your loan off.

  • Maybe the interest is right over there,

  • and 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 this is what you're paying down from the loan.

  • For a hybrid adjustable rate mortgage,

  • after that 5 year period, the bank

  • can now change the interest rate.

  • The interest rate is going to be dependent

  • on some kind of underlying thing

  • that everyone is paying attention to.

  • That underlying thing increases in interest.

  • In this 5/1 ARM, it starts off at a 3% interest.

  • If, because of the 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.

  • 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.

  • They typically, I should say, have a 30 year term.

  • 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 5 years

  • the amount of interest you pay might actually

  • change, so your payment might actually change.

  • 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 in, I can do that part in that same blue color.

  • For year 6, since this is a 5/1 ARM,

  • they can't change the interest rate again until year 7,

  • so you'll pay this constant amount until year 7.

  • Then, they can change the rate again.

  • 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 year 7, especially if interest rates go up a lot.

  • Now, you might be asking what determines

  • what that new interest rate is in after the 5 years.

  • They usually pick some type of index.

  • The most typical are, especially in the United States,

  • treasury securities; so, they'll look at the 10 year

  • interest rate that essentially the government

  • has to pay when it borrows money,

  • and they'll usually take some premium over this.

  • If the 10 year treasury is 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,

  • maybe you'll pay that plus 1%.

  • 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 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%.

  • 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's a little riskier,

  • because you really don't know