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,