Types of Mortgages
Fortunately for buyers, there are a variety of mortgages to choosefrom. It is in your best interest to investigate each of them todetermine which is the best for your situation. You probably won'tqualify for all of them. In fact, you may only qualify for one. But ifyou do qualify for more than one, you may save yourself money (andworry) in the long run if you do your homework before signing on thedotted 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.
Sincemost home loans are for a period of 30 years, if you want a payment youcan count on for that long of a period of time, a fixed rate mortgagemay be what works best for you. Once your loan amount and interest rateare calculated and locked in, a fixed rate mortgage will guarantee thatyou will have the same payment over the life of the loan. Making extrapayments to principal will allow you to pay your loan off sooner.
This may not always be the best choice, however. If interest rates arevery high at the time you take out your loan, with a fixed ratemortgage you'll be stuck with that high interest for the life of theloan (unless you choose to refinance). Conversely, if interest ratesare very low, you'll come out the winner with interest rates that willstay 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:
15-Year Fixed-Rate:
- 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:
- 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 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 foryour 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 ifinterest rates are very high at the time you take out your loan, anadjustable-rate mortgage (ARM) may be the solution for you. You mightalso choose this type of loan if your planned ownership of the propertyis short-term or if you expect your income to increase to cover anypotential rise in the interest rate.
Generally, the interest rate when you take out your loan willbe lower than a fixed-rate mortgage. Please note that this is trueinitially, not necessarily long-term.
Since an ARM rate rises and falls depending on the prevailinginterest rate, your mortgage payment will rise and fall accordingly. Ifyour income is not sufficient to cover the highest possible payments,then this option is not for you. On the positive side, the lowerinitial payments will allow you to qualify for a larger loan than ifyou choose a fixed-rate. The downside is that your payments willincrease if/when the rates go up.
Typically, ARM interest rates are tied to a specific financialindex (such as Certificate of Deposit index, Treasury or T-Bill rate,Cost of Funds-Indexed Arms or COFi, or LIBOR [London Interbank OfferedRate]) and your payment will be based on the index your lender usesplus a margin, generally of two to three points. Get the formula usedby your lender in writing and make sure you understand what it means.
Fortunately, the amount an ARM can increase is limited. Thereare "caps" on how much your lender can increase your rate, both for aperiod of one year and for the life of the loan. Plan ahead, and haveyour lender calculate what the maximum payment would be if your ratewent to the highest amount allowed by the cap for your particularmortgage. If you are not confident you'll be able to pay that amount ona monthly basis, perhaps you should reconsider this type of loan.
Convertible ARMs
If neither the fixed-rate or the adjustable-rate mortgage seems likethe best option, perhaps the convertible ARM will be right for you.This alternative combines the initial advantage of an ARM with a fixedrate after a predetermined number of years. Obviously, this type ofmortgage has more advantages when the initial interest rate is low andthe future rate is not guaranteed.
Government Loans
Another mortgage option available to some people is a governmentloan, providing that you meet the qualifications for these loans.
VA Loans: Veterans may qualify for a loan from the VeteransAdministration. There is a limit on the amount you can borrow, so this option works best for those buying a lower priced home..
FHA Loans:The Federal Housing Association offers loans to lower-income Americans.Look for the phrase "FHA approved" when looking at ads for homes.
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