Which mortgage term is best for you?

Once you've decided to take the plunge and switch from renter to homeowner, your first step should be to research your financing options so that you can decide which loan term best suits your needs.

The Mortgage Bankers Association reported that 85 percent of purchase home loans in June 2012 were 30-year fixed-rate mortgages

Fixed-rate home loans

Fixed-rate home loans are available in a variety of terms, including 30, 20 and 15 years. Some lenders even offer less-popular 7, 10, 17 or 25-year loan terms.

"Thirty-year fixed-rate mortgages are really the driving force behind homeownership in the U.S. because they offer the lowest monthly payments along with the security of stable payments," says Malcolm Hollensteiner, director of retail sales for TD Bank headquartered in Cherry Hill, N.J., and Portland, Maine.

Gregg Busch, vice president of First Savings Mortgage Corp. in McLean, Va., says there's really no downside to fixed-rate loans because they offer first-time homebuyers

While the monthly payments on 30-year mortgages are lower, 20 or 15-year mortgages

"Your monthly payments will be about 28 to 30 percent higher on a 15-year mortgage compared to a 30-year mortgage," says Busch. "If you can afford the higher payments, a shorter loan allows you to build equity much faster."

Monthly payments

Let's consider what the monthly payments would be on a $300,000 mortgage at various fixed-rate terms:

30-year mortgage at 3.86 percent: $1,408
20-year mortgage at 3.65 percent: $1,763
15-year mortgage at 3.16 percent: $2,095

Just five years into the loan, the difference in the loan balance between the 30-year and the 15-year loan is nearly $60,000.

Hollensteiner says most first-time homebuyers choose 30-year terms because they tend to focus more on keeping monthly payments low rather than paying off the loan balance. However, building equity more quickly benefits homeowners who wish to refinance or intend to sell in the near future.

Adjustable-rate mortgages

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"If a first-time buyer is not planning to stay in their home longer than the fixed term or is not maxing out their ability to handle their mortgage payments, an ARM might be an option," says Jeff LaMonte, senior vice president for retail sales and business support with Bank of America in Bakersfield, Calif. "If borrowers fully understand the loan and can afford to make the highest possible payments after the loan adjusts, they may be willing to take the risk in order to save on their initial mortgage payments."

Monthly payments

Given the lower interest rates, monthly payments on an ARM are going to be a few hundred dollars less than a 30-year fixed. The monthly payments on a $300,000 mortgage with a 5/1 Hybrid ARM rate of 2.80 percent would be $1,233 for the first five years and then would adjust each year after.

Of course, the downside of any ARM is that your monthly payments may increase after the fixed-rate period expires. Today, most ARMs are capped at about 5 percent (the interest rate can only rise by five percent over the life of the loan). In the example above, the interest rate could rise to a maximum of 7.80 percent, increasing the monthly payment by nearly $1,000.

Now that you understand which mortgage terms are available on the market today, consult with a mortgage lender to discuss your individual financial circumstances and which product is right for you.

(Remember, mortgage rates change daily, so the interest rates used to provide examples in this article may not reflect current rates. Check back in with HSH.com for today's mortgage rates

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Which mortgage term is best for you?