When you need to borrow money, you want to be sure you are doing so wisely. Knowing your options and understanding the strategy and consequences of each can prepare you to make the best possible decision.
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It’s a good idea to determine the right mortgage loan for you by analyzing your budget with a mortgage calculator and reviewing your fiscal goals. Below is a rundown of options to finance your new home.
30-Year Fixed-Rate Loan
This loan includes a predictable payment and interest rate until paid off — unless you decide to refinance your loan. Although it would push your payments a little higher, you may be able to incorporate your property taxes and homeowners insurance, depending on the lender. This loan can be a good option if you are looking for stability, since your monthly payments are guaranteed to stay the same. But if you suspect interest rates will go down, it may not be the best option because the rates are fixed. This makes budgeting and long-term planning easier, but makes sense only if you plan to stay in the home for at least three to five years.
With the 15-year option, you will be paying higher monthly installments but you will be done in half the time of a 30-year mortgage. The loans are fixed similarly in interest rate and payments, so are a great option if you can afford the higher payments and do not expect any major changes in your near financial future. This can be good if you are looking to quickly build equity in your home as well.
Adjustable-rate mortgages (ARM) mean that interest rates are re-assessed regularly, sometimes as often as every month, based on market trends. Depending on your specific loan agreement, the initial adjustment can occur after one, three five or even seven years. Typically, the loan starts with a fixed interest rate, which can change with the market. This is dangerous if the adjusted rate is substantially higher than the one you were accustomed to paying. (The rate can also go down, but given the low market rates now, that seems very unlikely.) However, this can be a good option if you expect your income to increase soon and you want to work toward owning the house for the long term. With adjustable-rate mortgages, there is a limit to how high the interest rate can go so it’s important to pay attention to that number when deciding if this is the type of loan for you.
Payments in an interest-only loan are used solely towards the interest for a set period of time, usually 5 to 10 years. Depending on the loan terms, the rate may be fixed or adjustable. Once the interest-only period ends, the loan works regularly for the rest of the mortgage term and you become responsible for paying both the principal and interest, a higher monthly cost. This option keeps expenses lower at the outset, enabling home buying even for those just beginning their career or focusing on other expenses for now. However, it’s important to note that you aren’t building any equity in the home during the beginning when you are paying only interest. This can be a problem if you want to refinance. These loans are increasingly uncommon since the Great Recession.
By understanding the common loans available, you should be able to determine which mortgage is best for your home and your financial health. You can get the best deal possible by knowing your options and considering all possibilities. Your credit score can have a major impact on choosing which mortgage type is right for you. Before you shop for a mortgage, it’s smart to know where you stand. (You can take a look at your credit scores for free on Credit.com.)