Mortgage Loans: Understanding Risk and Prices

Tim Worstall
LoanBiz Columnist

Article Rating , 4 out of 5 based on 1 votes

California mortgages, like mortgages or loans of any kind, are priced based on the amount of risk to the lender.

 It is essential that you understand how this risk is priced between you and the mortgage companies. You can get a lower price by accepting more risk, or the mortgage companies can shoulder more of the risk and will thus require a higher price. If you don't understand this trade off then you'll never be able to come to grips with the different types of mortgage loans available, and you'll not understand why the mortgage companies vary the prices as they do.

Pricing Interest Rate Risks

One major risk for both you and the mortgage companies is that over the life of the loan financial markets and interest rates will change. California mortgages come in two major types: with fixed interest and adjustable rates (ARMs). If the interest rate is fixed, then it is the mortgage companies who bear the risk of interest rates going up: if they go down, you can always refinance into a lower rate. If the rate is adjustable, then you carry the risk of future interest rate rises and also benefit from falls. So with an adjustable California mortgage, the mortgage companies face less risk. They are therefore willing to charge you a lower start rate on such a mortgage. Whether you want to accept such risk is a different matter. With an ARM, you can get lower prices (lower payments) now in exchange for accepting the risk of higher payments in the future. But you do need to understand this trade off to be able to make an informed decision.

About the Author
Tim Worstall has a degree in finance and accountancy and writes extensively on matters economic and financial.

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