Fortunately for buyers, there are a variety of
mortgages to choose from. It is in your best interest to investigate
each of them to determine which is the best for your situation. You
probably won't qualify for all of them. In fact, you may only qualify
for one. But if you do qualify for more than one, you may save yourself
money (and worry) in the long run if you do your homework before
signing on the dotted line.
Fixed Rate Mortgages
Consider a fixed rate mortgage if either of the following describes you:
- You plan on living in your new home for many years, and/or
- You are not a risk-taker and prefer the stability of knowing how much your payment will be each month.
most home loans are for a period of 30 years, if you want a payment you
can count on for that long of a period of time, a fixed rate mortgage
may be what works best for you. Once your loan amount and interest rate
are calculated and locked in, a fixed rate mortgage will guarantee that
you will have the same payment over the life of the loan. Making extra
payments to principal will allow you to pay your loan off sooner.
This may not always be the best choice, however. If interest rates are
very high at the time you take out your loan, with a fixed rate
mortgage you'll be stuck with that high interest for the life of the
loan (unless you choose to refinance). Conversely, if interest rates
are very low, you'll come out the winner with interest rates that will
stay low no matter how high interest rates go in the future.
The following are the advantages and disadvantages of the varying lengths and terms of fixed-rate mortgages:
- Pay off the loan in half the time of a 30-year loan.
- Equity builds up more quickly than in a 30-year loan.
- Payments are higher (which may be a problem if you lose your job or become unable to work).
- Pay off the loan in 2/3 the time of a 30-year loan.
- The overall interest paid is considerably less than for a 30-year loan.
- The most common choice, especially for first-time homebuyers, as it's the easiest of the fixed-rate loans to qualify for.
- Monthly payments are lower than for 15-year
and 20-year loans. This can prove especially helpful if you do not have
a lot of "padding" between the amount you can afford to spend and the
monthly payment for your desired property.
- More desirable if you plan on staying in the same home for years, since equity builds more slowly than for shorter-term loans.
- For income tax purposes, this term provides the maximum interest deduction.
If you are more comfortable in taking a risk with your money or if
interest rates are very high at the time you take out your loan, an
adjustable-rate mortgage (ARM) may be the solution for you. You might
also choose this type of loan if your planned ownership of the property
is short-term or if you expect your income to increase to cover any
potential rise in the interest rate.
Generally, the interest rate when you take
out your loan will be lower than a fixed-rate mortgage. Please note
that this is true initially, not necessarily long-term.
Since an ARM rate rises and falls depending
on the prevailing interest rate, your mortgage payment will rise and
fall accordingly. If your income is not sufficient to cover the highest
possible payments, then this option is not for you. On the positive
side, the lower initial payments will allow you to qualify for a larger
loan than if you choose a fixed-rate. The downside is that your
payments will increase if/when the rates go up.
Typically, ARM interest rates are tied to a
specific financial index (such as Certificate of Deposit index,
Treasury or T-Bill rate, Cost of Funds-Indexed Arms or COFi, or LIBOR
[London Interbank Offered Rate]) and your payment will be based on the
index your lender uses plus a margin, generally of two to three points.
Get the formula used by your lender in writing and make sure you
understand what it means.
Fortunately, the amount an ARM can increase
is limited. There are "caps" on how much your lender can increase your
rate, both for a period of one year and for the life of the loan. Plan
ahead, and have your lender calculate what the maximum payment would be
if your rate went to the highest amount allowed by the cap for your
particular mortgage. If you are not confident you'll be able to pay
that amount on a monthly basis, perhaps you should reconsider this type
of loan. Convertible ARMs
If neither the fixed-rate or the adjustable-rate mortgage seems like
the best option, perhaps the convertible ARM will be right for you.
This alternative combines the initial advantage of an ARM with a fixed
rate after a predetermined number of years. Obviously, this type of
mortgage has more advantages when the initial interest rate is low and
the future rate is not guaranteed.
Another mortgage option available to some people is a government loan,
providing that you meet the qualifications for these loans.
- VA Loans: Veterans may qualify for a loan from the Veterans
Administration. There is a limit on the amount you can borrow, so this option works best for those buying a lower priced home.
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