Mortgages: Which one is right for you?... by Kathy Scott
So you're ready to buy a home. Finding that perfect home can be a great adventure. Seeking out the mortgage that's right for you can be difficult. There are a dozen or more options available for financing a home, and it's important to consider the pros and cons of each. Before looking into more complicated choices, consider the most common.
The most common home loans are the 30-year and 15- year fixed rate mortgages. With this type of mortgage a lender amortizes the interest rate and the home price over 15 or 30 years depending on the loan. You are given a monthly payment that never changes over the life of the loan. Fixed rate mortgages have been extremely popular over the past several years because interest rates have been so low. According to Freddie Mac, an organization chartered by Congress to expand opportunities for home ownership, the current 30-year mortgage interest rates are at their second lowest average in 32 years. Homeowners also enjoy knowing that their monthly payments will never change.
If you decide to go with a fixed rate mortgage, consider both the 15-year and 30-year fixed rates. You might be surprised to know that monthly payments on a 15-year fixed can be only slightly higher per month than a 30-year fixed, and the savings on interest over the life of the loan can be substantial. Rates for a 15- year fixed (5.23% avg) are also lower than those of a 30-year fixed (5.75% avg) according to Freddie Mac. So, if you borrow $200,000 against these two average rates, your monthly payment for a 15-year fixed would be $1,606 per month, paying $89,018 in interest over 15 years compared to $1,167 per month for a 30-year fixed, which will cost you $220,172 in interest over the life of the loan.
Another common mortgage is an Adjustable Rate Mortgage (ARM), popular because it offers even lower interest rates than fixed rates with some as low as 3.5 or 4%. Lower rates allow the borrower to afford more home, but with ARMs, the rate only stays stagnant for a limited period of time - 1, 3 or 5 years.
This type of loan is a great choice for borrowers who don't plan to be in the home longer than the fixed period. The current ARM rate averages 4.17%. Using that rate on a $200,000 loan, the borrower would pay $975 per month, but once the ARM adjusts after a fixed period, the monthly payment could jump substantially, and it adjusts every year thereafter for the life of the loan.
If you're considering this type of loan, make sure your lender offers some protection against a huge interest rate increase with a cap. Caps restrict the amount the interest rate of an ARM can adjust. The two most common caps are Periodic Rate Caps which limit the amount a rate can change at any given time and Lifetime Caps which restrict how much the interest rate can rise over the life of the loan. Some lenders also offer a conversion feature on an ARM that allows the borrower to eventually convert it to a fixed rate for a fee.
Whatever loan you choose, make sure you understand all the fees associated with it. Use a mortgage company with a good track record and talk to several lenders.