A new home purchase is full of big decisions. Location, style and price are all major concerns. Then there’s the decision of how to pay for the home. Most homeowners obtain a mortgage so they can pay off the home in monthly installments. Even this decision is full of options for the new homeowner.
Which lender to go with, what type of loan to choose and how long it will take to pay off the mortgage are all among the decisions that need to be made. There are many different options for the type and duration of the loan. Figuring out the difference between the options and choosing the right one may require some time. Here is some information to make the process a little less confusing.
Fixed- or adjustable-rate mortgages
Two of the main types of mortgages are fixed-rate and adjustable-rate mortgages. A fixed-rate mortgage is one that has an unchanging interest rate, no matter the market conditions. For the entire life of the loan, monthly payments will be the same amount.
One advantage to the fixed-rate mortgage is the predictability between payments. This makes it easier for homeowners to create long-term budgets. According to the Home Buying Institute, this is typically used for 30-year mortgages. In other words, they are preferred by those seeking the lowest monthly payments and those who plan to stay in the house for a long time.
“A fixed-rate mortgage is one that has an unchanging interest rate.”
With an adjustable-rate mortgage, the interest rate is susceptible to change according to the market conditions. An ARM is less predictable than a fixed-rate loan, but there are some unique advantages to it. This loan will generally begin with a lower interest rate than the fixed-rate mortgage, giving the homeowner the lowest monthly payment possible, but it is expected to increase once the interest rate adjusts. A cap is determined at the beginning of the loan that will make sure any rate changes won’t exceed a predetermined amount however.
Hybrid mortgages are also a possibility for new homeowners. This is a fixed-rate mortgage for a decided number of years (usually at three, five, seven or ten), at which point the rate will change according to the economic climate. The adjustment may be a one-time change, or a change that occurs regularly over the balance of the loan term, usually once a year. This loan may be best for homeowners who are certain they will no longer own the home by the end of the loan’s fixed-rate period.
While loan type is an important decision to make when taking out a mortgage, it is also important to consider the amount of time it will take to pay it off. The duration of the loan is decided at the time the loan is originated. Options generally include 10-, 15-, 20-, 25- and 30-year options, though the two most popular are the 15- and 30-year mortgage loan.
A 15-year mortgage is advantageous for anyone who doesn’t plan on staying in the home for a long period of time or who is preparing for retirement, Money Crashers said. Since there are 15 fewer years to pay interest on than with a 30-year loan, people who choose this loan option will spend less on interest payments overall. However, since the amount of money is expected to be paid in half the time, monthly payments are larger.
According to Get Rich Slowly, choosing a 30-year mortgage doesn’t mean a person can’t work toward owning the home quicker. Extra payments or larger payments than required can be made to pay off the mortgage in 15 years, for example. This way, the homeowner saves money because they won’t pay interest for the remainder of the loan. However, if circumstances change, the homeowner can continue to pay exactly what is owed each month. A 30-year loan has the advantage of lower monthly payments. In the long run, those who choose the 30-year loan will pay more money on interest, but their monthly payments are more manageable. This is ideal for anyone who is uncertain about their future income. It’s also a great option for someone planning on living in the house long-term.