Choosing a Home Mortgage Plan

Just over a decade ago prospective homeowners had only the fixed rate mortgage, making the only chore for borrowers a comparison shopping trip for the best rates.

Not so today. The introduction of the adjustable rate mortgage (ARM) in the early 1980s was the beginning of a “new wave” in mortgage financing.

These new entries into the mortgage market offer flexibility without new closing costs.

Reduction Option Loan. A 30-year fixed rate mortgage with a one-time option, available in years two through five, to reduce the interest rate on the loan to the prevailing rate (if that rate drops at least two points within a single year). The cost of exercising the option varies, with some lenders charging 1/4 of a percent of the principal plus $100.

For a reduction option privilege, the borrower’s initial interest rate is about 1/4 of a percent higher than comparable 30-year fixed rate loans. The borrower can refinance for less than the usual cost, however, and the process can be activated with a phone call, saving the homeowner from the complete loan application process normally required for refinancing.

Convertible ARMs. An otherwise typical one-year adjustable rate mortgage, with an option to lock in a fixed rate, again in the second to fifth years of the mortgage. The price is typically about 1 percent of the outstanding balance and/or a flat fee of about $250. The mortgage rate is slightly higher than a conventional ARM, but the costs of refinancing are avoided, and the process simplified.

Fixed Payment ARMs. The rate on this one-year adjustable mortgage fluctuates, but the amount of the monthly payment remains fixed. To offset changing rates, the actual term of the loan is lengthened or shortened accordingly.