A couple n00b housing questions. . .

[Koenigsegg]

a) What's the difference between a "rate" and "APR"? Does the rate refer to a different period of time if APR refers to a year?

b) What's ARM? As in 5/1 ARM, 1-year ARM, etc...

 

[dullard]

Suppose you borrow $10,000 from me. And suppose I charge you interest once a year on the remaining balance at a 10% interest rate. After one year, you owe me $1,000 in interest (10% of $10,000). Total owed is $11,000.

Now suppose instead I charge you interest twice a year on the remaining balance. Six months in, you owe me $500 interest (half a years interest on $10,000). Then six months later you owe me $525 interst (half a years interest on $10,500). Total you owe me is $11,025.

See the difference? In the second case, you owe interest on the interest. So effectively you owed me 10.025% interest on that $10,000 after one year. This 10.025% number is the APR. The rate is the same in both cases: 10%. Note: mortgage interest is often done on a monthly basis, so you owe interest on the interest 12 times in that year. The APR can be noticibly higher than the rate in that case. Always use APR to compare one loan to another.

 

[dullard]

An ARM is a fixed loan that becomes variable later on. For example, a 1-year ARM will be fixed interest for one year, and then interest will vary after that one year. A 5-year ARM will be fixed interest for 5 years, and then interest will vary after that 5th year. A typical standard mortgage is fixed interest for the entire time: 30 years.

ARMs are great for two cases:
1) When interest rates are likely to go down in the future and you plan to be in the house for a long time. You then get lower payments as interest rates drop from their highs.
2) When interest rates are likely to go up in the future and you plan to be in the house a short time. In this case, you take the low payments now and move before you are raped with the higher payments.

In all other cases, ARMs are really bad choices.

It is always a gamble. No one can guarantee that rates are going to be higher or lower in 3, 5, 7 years. Also, do you really truely know how long you'll stay?

 

[Sex Smurf]

b) ARM = Adjustable Rate Mortgage.
So a 5/1 ARM would be a fixed rate for 5 years, then adjustable after that. It's a good play if you plan to sell your house before 5 years because most likely, after 5 years, your rate will be much higher than the fixed period.

1-year ARM = fixed for 1 year.
3/1. . .etc.

*you beat me to it dullard!

 

[Toasthead]

the RATE is meaningless. The APR is the RATE with all associated costs (paid up front) applied. THE APR is what you need to look for.

 

[chuckywang]

Originally posted by: dullard
Suppose you borrow $10,000 from me. And suppose I charge you interest once a year on the remaining balance at a 10% interest rate. After one year, you owe me $1,000 in interest (10% of $10,000). Total owed is $11,000.

Now suppose instead I charge you interest twice a year on the remaining balance. Six months in, you owe me $500 interest (half a years interest on $10,000). Then six months later you owe me $525 interst (half a years interest on $10,500). Total you owe me is $11,025.

See the difference? In the second case, you owe interest on the interest. So effectively you owed me 10.025% interest on that $10,000 after one year. This 10.025% number is the APR. The rate is the same in both cases: 10%. Note: mortgage interest is often done on a monthly basis, so you owe interest on the interest 12 times in that year. The APR can be noticibly higher than the rate in that case. Always use APR to compare one loan to another.

But the interest will decrease if you are paying back the loan during that year.

 

[dullard]

Originally posted by: chuckywang
But the interest will decrease if you are paying back the loan during that year.

Yes, but what does that have to do with my post or Koenigsegg's question?