1 Mortgage Essential and 1 Trap to Avoid at All Costs
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Choosing the right type of mortgage can mean the difference between crushing budget goals or falling short. Especially when buying a home is the single, largest expense you'll incur throughout your life.
Clearly, it pays to get the right information to make an informed decision. With that in mind, Motley Fool analysts, Kristine Hartjes and Nathan Hamilton, discuss in the video below one mortgage essential to know and one trap to avoid at all costs.
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KRISTINE HARJES:
Beginners to the mortgage process might look at ARMS, or adjustable rate mortgages, and say, "Oh my gosh, this is great. I should absolutely go for this," because it often looks cheaper. Is that the case normally?
NATHAN HAMILTON:
It can be, yes. An adjustable rate mortgage before we get into some details and essentials, and a trap to avoid is you've got two types of mortgages, adjustable and a fixed rate. So if you were doing a 30-year term for both, the fixed is going to have a higher, but fixed-rate. Adjustable is going to change over the life of that mortgage.
KRISTINE HARJES:
So in general, which one is cheaper?
NATHAN HAMILTON:
If rates hold the same, generally an ARM is going to be cheaper. Many come in the form some terminology to throw out there of say a 5 in 1 ARM. And what that means is for the first five years that rate is fixed, and then every year it adjusts. So if that rate actually stays flat for 30 years (which in all likelihood is not going to happen), you're going to be getting a lower rate then what you would with a fixed mortgage.
KRISTINE HARJES:
And is there any way to know how much it's going to be adjusted by?
NATHAN HAMILTON:
With any of the documents that you're signing at origination or when you're going through the research process, there are going to be different details, and the one essential to know is the interest rate caps. And as you look at it, there's a periodic cap, which is going to be in our example of the 5 in 1, every one year the mortgage interest rate can only increase, or even decrease a certain amount.
KRISTINE HARJES:
So that's what you were mentioning before with the 5 in 1. That's your periodic cap. You also said there's a lifetime cap. How does that one work?
NATHAN HAMILTON:
This protects you from, essentially, skyrocketing mortgage payments, which we've seen before. And that's over the life of the loan say 15, 30-year, whatever ARM you take out the interest rate can only increase a certain amount. So it does protect us as mortgage owners. As buyers of homes. And it's not so much a huge advantage for banks, but it is a protection.
KRISTINE HARJES:
That does seem really essential to know. Just a little security blanket knowing, "OK, this might wiggle around a little bit, my interest rate, but ultimately I do have that protection of knowing that there's a cap." Are there any other traps to watch out for?
NATHAN HAMILTON:
There is a trap, definitely. There's other mortgage terminology out there, and one of those is rate vs. APR. And if you look at it, the rate is a teaser rate that you see online. You may be hit with an ad. And that, essentially, accounts for just the cost of the mortgage. The APR is your true cost, and it counts for all of the fees that are rolled into the mortgage. The trap you want to avoid is if you're calculating what the cost of your 30-year mortgage is going to be and you're doing it off of the rate, you're going to be far off from what the actual cost is to you as an owner.
KRISTINE HARJES:
Got it. So always important to consider APR instead of just looking at rates.
NATHAN HAMILTON:
Yup.
KRISTINE HARJES:
If you're looking for more information and to compare some APRs on mortgages, you can head to Fool.com/Mortgages, where you can also get in contact with certified lenders, and you can also download some of our free guides, such as "5 Tips to Increase Your Credit Score Over 800."
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