An Important Consideration
Before you select a mortgage, ask yourself, "How long do we plan to remain in this house?" Once you have decided, you will be able to better focus on the mortgage that will be best for you.
This point is important because it helps determine the length of time you may want your interest rate to remain fixed. As long as your rate is fixed, your monthly payment for principal and interest will remain the same. Most mortgages offer rates that are fixed for a period of time. Some are fixed for the entire term of the loan while others may be fixed for only a few years. Generally, the longer the period of time for which a rate is fixed, the higher the starting interest rate.
You may want to pay the lowest interest rate that will accommodate your needs for the time you have the loan. Therefore, if you plan to be in your home for just a few years, it is not necessary to pay for fixed rate security beyond that term. So remember to consider how long you will be in your home before you select a mortgage. This will save you money.
The Two Basic Mortgage Types
There are two basic forms of mortgages to choose from:
Fixed Rate Mortgage
In a fixed rate mortgage, the interest rate remains the same over the life of the fixed rate loan. Typically, the term is 15 or 30 years. As a result, the monthly payment for principal and interest will remain the same. Payment changes may occur however, when property tax costs (which are generally paid in monthly installments along with the mortgage obligation we discussed earlier) increase or decrease. These generally are rather modest annual changes. This may be the best mortgage for a borrower who plans to remain in the home for a long period of time, usually 10 or more years.
Adjustable Rate Mortgage
The interest rate on an ARM may be adjusted periodically (every year, for example) according to changes in some economic indicator. These are called adjustment intervals. To monitor economic change, an index (usually the rate paid on U.S. Treasury Securities, the 11th District Cost of Funds, or other recognized financial barometers) is used. A margin is added to the current index interest rate at each adjustment interval. This is the lender's premium. The index plus the margin equals the fully indexed ARM rate.
Virtually all ARMs offer beginning interest rates substantially lower than the fully indexed rate.
An ARM's initial rate is only temporary. At the first adjustment interval, the ARM's rate (and the corresponding monthly payments) will usually rise by the maximum increase allowed. Thereafter, up and down adjustments will occur at each adjustment interval according to the changes in the index used.
To limit excessive changes in rate at each adjustment interval, as well as the maximum amount by which the interest rate may increase above its beginning rate, rate caps are included with ARMs. These caps are typically expressed as percentages. For example, 2% and 5% caps mean that 2% is the maximum interest rate increase for each adjustment interval, and 5% is the maximum increase throughout the life of the ARM. An ARM may be best for a borrower who plans to remain in the home for ten years or less.
Customizing Your Loan
Once you've selected a basic mortgage type, it is time to begin assembling the features that will make it the ideal loan for you. Here are a few of the options you may wish to consider:
Pricing Options
If you wish, you may reduce the interest rate of your mortgage, and in turn, your monthly payments. To reduce the interest rate, you pay discount points. A point is equal to 1% of your loan amount. Paying discount points is an excellent option for homebuyers who plan to be in their home for a long period of time. They would save more in interest costs than the amount paid in points to discount the rate.
Shorter Terms
If you can afford a monthly payment that is 8-20% higher than the payment on a 30-year term loan, you may wish to consider a 15-or-20 year term loan. You may save substantial costs in interest by choosing either of these reduced-term loans. The shorter the term, the less interest you will pay over the life of the loan.
Mortgage lending may truly seem like a jungle of terms and concepts. But it really is not as complicated as it seems. We will assist in selecting the loan program that is right for you.
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