When you obtain a mortgage loan, you borrow the principal, the amount of money required to pay for the property, and you pay interest, what the lender charges you to borrow the money. The way the payments are spread out over the life of the loan, you pay more in interest than principal in the early years, which gradually reverses itself as the loan ages.
Mortgage loans come in a variety of flavors, one of which will best suit different borrowers with different situations. To find the best loan for your needs, think about your short and long term plans, your financial goals and your risk tolerance. Here are some scenarios to consider, along with the generally recommended home loan types for each. Individual borrower situations vary.
If you plan to live in your home for many years,
Look for a low interest rate over a long period of time. Since you're going to be making payments for many years, your best strategy may be a fixed rate loan and pay points to get your rate as low as possible.
If you want to budget for a fixed payment each month, or don't want to risk paying higher interest rates,
Avoid adjustable-rate or balloon loans. A fixed rate loan has a principal and interest payment that stays the same for the entire term of the loan. Loan terms can range from 10 to 40 years, though the most common is a 30-year loan. Many borrowers take advantage of another option: a “biweekly” mortgage, where you pay half of your monthly payment every two weeks. This results in an extra payment being made every year, which shortens your mortgage term.
Fixed rate loans are the most stable and the least flexible loans. They are recommended if you are planning to keep your home for many years, can easily qualify for the loan amount, want to lock in a low rate and expect overall interest rates to increase or remain the same.
If you plan to sell or refinance your home in just a few years,
You may wish to avoid points and closing costs, since the difference in interest payments won't typically make up for your out-of-pocket expenses at closing. Also, look for a loan that enables you to commit to a smaller down payment. An ARM is usually a good choice for holding rates down for a set number of years.
If you want to pay off the home loan by the time you retire or your kids are in college,
Shorter-term loans are an excellent way to ensure that you can use your income for other goals later in life. Another benefit is that you build equity faster.
If you are comfortable with the risk of higher interest rates if it means you can qualify for a larger mortgage right now.
Adjustable rate mortgages are a great solution for people with incomes that are going to grow and who will quickly refinance or be able to afford a larger payment in a few years if interest rates rise.
Click here to see a description of all the loan options.
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