Finding a mortgage
can be a strenuous process. Not only are there hundreds of institutions
offering mortgages, it can seem as though there are dozens of different
types of mortgages themselves. Different interest rates, different lengths
and other features can be confusing. This article describes some of the
different options you may encounter as you shop for a mortgage. As you
review your options, keep two thoughts in mind:
- How long do you
expect to live in the home?
- What is your tolerance
for monthly payments increasing?
Fixed Rate Mortgages
As the name implies, with a fixed rate mortgage, the interest rate
is set at the time you take out the mortgage and remains constant over
the life of the mortgage. The monthly payment level also remains constant.
Knowing what your payment will be can be reassuring.
Each monthly payment
is comprised of interest and principal with early year payments being
primarily interest and payments toward the end of the mortgage being mostly
principal. Most of the mortgage pay down comes late in the mortgage period.
offer fixed rate mortgages of 30 years and 15 years. The benefit of the
shorter 15-year mortgage is that after 15 years you will have paid off
the mortgage loan and you own your home free and clear. You will also
pay less interest over the life of the mortgage. The negative is that
your monthly payments will be higher.
a 15-year mortgage and a 30-year mortgage
monthly payments over the term of the mortgage
principal paid over the term of the mortgage
interest paid over the term of the mortgage
Choosing the term
of a fixed rate mortgage is usually a function of what level of monthly
payments you can afford and how anxious you are to pay off the entire
With an adjustable rate mortgage, the interest rate and monthly payments
can change as interest rates change. The rate is fixed initially and is
subject to being reset based on changes in some interest rate benchmark.
The big benefit to the borrower is that usually Arms have interest rates
(at least initially) that are lower than the rates on fixed rate mortgages.
Sometimes it can even be 1½ to 2½ % less.
There are several
features of Arms that you should evaluate if you are considering this
type of mortgage.
- Initial rate. Be
careful if the initial rate seems real low. It could be a "teaser" rate
that only lasts for a short time and then the rate is adjusted upward.
At a minimum, ask what the rate would be adjusted to if the initial
rate ended today.
- Benchmark the ARM
is pegged to. ARM rates are usually tied to some "published" index that
reflects the general interest rate market. Usually the ARM rate is adjusted
to that benchmark plus some level of margin. Ask the lender how this
works and try to get an understanding of how the benchmark rate has
- The cap. Most Arms
have limits on how much the rate can rise in any one year and some Arms
have a limit to what the rate can rise to over the course of the mortgage.
Understanding how the caps work will let you know "how bad it can get"
if rates rise substantially.
- Length of the
rate periods. When you look at Arms you may find there are terms like
10/1, 2/7, 4/1 and the like. These refer to how long the initial rate
lasts and how often the rate is adjusted after that.
Adjustable rate mortgages
are attractive because of their lower initial rate. Your risk is that
your rate and monthly payment will rise in the future. If you are comfortable
that you can accept an increased payment or if you think you will be moving
in a relatively short time, the savings with an ARM can be substantial.
Negative amortization. Amortization refers to the process of paying
down a mortgage. Some lenders offer mortgages with lower monthly payments
than what is needed to pay interest and ultimately pay off the mortgage.
This means the amount due on your mortgage increases over time. Avoid
this type of mortgage.
Balloon mortgages are similar to fixed rate mortgages with steady monthly
payments using a 15 or 30 amortization. However, with a balloon, the mortgage
comes due before 15 or 30 years. Most balloon mortgages are for 3 to 7
years. They usually offer lower interest rates than the traditional 15
or 30 year fixed rate mortgage. But, remember that with a balloon, your
mortgage will be due on a given date and you will have to do something.