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Buying a new home isn’t just about finding the right place to live. Once you’ve picked a great agent, and found your new home, you have to find a way to pay for it. Wading through the types of mortgages may seem intimidating, so here is a quick guide to which mortgage might be best for you.
Fixed Term
The most popular type of loan is a fixed rate loan. The 30-year fixed is the most popular loan in the United States, but the 15-year fixed loan is growing in popularity as it has a lower interest rate than its 30-year counterpart. Even better, the 15-year loan will save you a ton of money spent on interest payments over the life of the loan.
Fixed-rate loans amortize the total loan value, with interest, over a period of time. A fixed payment is made each month over the life of the loan, and at the end of the term the loan will have a zero balance. If you make larger monthly payments, or extra payments, the loan will be paid off faster.
To calculate a monthly payment you would need your interest rate and starting loan amount. Plug that information, along with the loan length, into a loan calculator to find your monthly payment. You can use this handy calculator from Bankrate to test out what happens as term, interest rate, and principle amount go up and down. While using this loan interest calculator, take a look at the difference in total interest paid between the 30-year and 15-year loans. The difference is staggering and worth the sacrifice if you can swing it.
ARM
ARM stands for adjustable rate mortgage. ARM mortgages have calculations similar to a fix-rate mortgage, but at a certain point in the life of the loan the interest rate adjusts and the monthly payment recalculates. This adjustment could be an increase or a decrease in the interest rate and total monthly payment.
The most popular types of ARM loans are generally around five to seven years fixed before the interest rate adjusts. Other options exist, however, such as a 15-year ARM from PenFed Credit Union.
Most people live in a home for about seven years, so a seven year ARM could make sense for many people to save money over the time they live in the home. However, if rates increase over that time your payment and interest cost will go up when your rate adjusts.
Interest Only
Some loans allow you to pay interest only on the loan balance without making principle payments. In general, this is a bad deal for the borrower.
As long as someone is paying interest only, they are essentially renting the home. To increase equity in the home, either the value must rise or you have to pay down the loan balance. You can’t control what the market does, but you can control what you pay. Paying down the loan might feel expensive, but it will help you become wealthier.
Balloon
A balloon loan gives you a very small payment up front and then, at a fixed date in the future, balloons and the payment dramatically increases.
This is the type of loan that got a lot of people into trouble during the financial crisis in the late 2000s, and I suggest avoiding them in almost all circumstances.
Jumbo
A jumbo loan is like a fixed-rate loan but for a very expensive property. Jumbo loans start at an amount between $625,000 – $1,000,000, depending on your state, and have slightly different interest rates due to the size, and risk, of the loan compared to typical homes. Typically jumbo loans start where the conforming loan limits of Fannie Mae and Freddie Mac loans stop.
What’s Right for You?
Everyone has a different financial situation, but in general the fixed-rate loans are the most popular for a reason. They are usually the best deal for most homeowners and they are the most predictable because they are not affected by the market.
However, there are always exceptions. If you are in the military, for example, an ARM loan might make more sense because you move around more. If in doubt, seek professional financial advice from a licensed expert.
But, if you’re like most of us, you should try to get the lowest term fixed-rate loan you can reasonably afford. The shorter the loan term, the more you save. With the right real estate agent at your side, the process of getting into your new home will almost always be easier and more enjoyable.
If you are buying or selling a house and are looking to hire a successful real estate agent to help you through the process, take a look at AgentHarvest's list of top-ranking local Realtors in your area. We found these agents by examining their sales track records, awards, rankings, client testimonials and by conducting personal interviews.
To me, the choice is simple. Get a 15-year fixed loan. You’ll be locked in to a fixed rate so you’ll be protected if interest rates climb and you’ll save a ton of money by applying more money to the principal. I’ve never seen any downside to this loan. You’ll save money and weather any storm no matter what the interest rates do in the future. If interest rates fall, just refinance to a lower fixed rate. If rates go up, give your loan documents a big hug and be glad that you’re locked in. Either way, you’re in control of your fate. I’ve also never understood the argument of “if you only live in a house for 3-5 years, use an ARM.” I’d rather pay down the loan and if I move, I’ll just use the equity gained in the first home from a 15-year mortgage to purchase the new home with a bigger downpayment and a lower loan, resulting in a lower monthly payment.
Another big advantage not touched on in the article is using a downpayment large enough to avoid having to pay mortgage insurance, not to be confused with homeowners insurance.
One final point, the more equity you can accumulate in your house, the safer you will be when it’s time to sell it, especially if the market drops, you can take the loss without affecting your pocketbook.