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 (or 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.
Since 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 descriptions of the varying lengths and terms of fixed-rate mortgages:
15-Year Fixed-Rate:
- You to 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).
20-Year Fixed-Rate:
- You to 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.
30-Year Fixed-Rate:
- The most common choice, especially for first-time home buyers, as it is easiest of the
fixed-rate loans to qualify for.
- Monthly payments are lower than for 15-year and 20-year loans.(Especially
helpful if you don't have a lot of "padding" between the
amount you can afford to spend & 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.
Adjustable-Rate Mortgages (ARMs)
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
type 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 will 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 isn't sufficient to cover the
highest possible payments, then this option isn't for you. On the positive side, the lower
initial payments will allow you to qualify for a larger loan than if you chose a
fixed-rate type. 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 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 rise is not unlimited. 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're 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 nor the adjustable-rate mortgage seems 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.
Government Loans
Another mortgage option for 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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