Guide - Selecting Your Loan Program
This article is excerpted from a publication of Fannie Mae
If you anticipate living in your home for
many years, the interest rate may be the
main factor for you. If you expect to keep
the house for only a short period of time,
the closing costs may be more important to
you. If you want to have ended any mortgage
debt by the time you are facing your
children's college bills or your own
retirement, you may wish to consider a
shorter term loan such as a 15-year
fixed-rate mortgage. If your own retirement
is years away, you may be less inclined
toward a shorter-term loan, preferring to
extend payments over a longer period of time
through taking on a 30-year mortgage loan.
How important to you is the certainty of a
fixed mortgage payment each month? If you
want to make sure your mortgage payment
remains the same each month, then you'll
want to focus on various fixed-rate loans.
If you are comfortable with periodic changes
to your mortgage interest rate, then you may
be inclined to consider adjustable-rate
mortgages.
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Fixed-rate mortgage loans
A fixed-rate mortgage ensures that
your interest rate (and your
payments) will stay the same over
the life of your loan - which may be
an important consideration if you
plan to stay in your home for
several years. When you choose the
length of your repayment (usually
15, 20 or 30 years), keep in mind
that while shorter term loans may
have higher monthly payments, they
also let you pay less interest and
build equity faster.
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30-year fixed-rate mortgage loan
The advantage of a 30-year
fixed-rate mortgage loan is that it
is the easiest to qualify for, and
it gives you an excellent
opportunity to keep your mortgage
payments reasonable by making
monthly payments over a long period
of time. This mortgage loan may be
ideal if you plan to remain in your
home for years and wish to keep your
housing expense low and use any
extra cash for other purposes. This
loan also provides maximum interest
deduction for tax purposes.
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20-year fixed-rate mortgage loan
The 20-year mortgage often offers a
lower interest rate compared to a
30-year loan. This mortgage
amortizes principal and interest
over a 20-year period, 10 years less
than the traditional 30-year
mortgage. This may save you a
considerable amount of total
interest paid over the life of the
loan.
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15-year fixed-rate mortgage loan
The advantage of a 15-year mortgage
is that its interest rate is lower
than a 30-year or 20-year mortgage.
Such a shorter-term mortgage will
save you a significant amount of
interest over the life of the loan.
By paying off the mortgage more
quickly, you also build up equity in
your home sooner. A 15-year mortgage
can let you own your home clear of
debt earlier, which may be important
if you are approaching retirement or
have other large expenses to cover
such as financing your children's
education. However, the monthly
payments you make on a 15-year
mortgage will cost you more than
those you would make on a 30-year or
a 20-year mortgage loan for the same
total mortgage amount.
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Adjustable-rate loans
With an adjustable-rate mortgage
(ARM), the interest rate you pay is
adjusted from time to time to keep
it in line with changing market
rates. This means that when interest
rates go up, your monthly mortgage
payments may go up as well. On the
other hand, when interest rates go
down, your monthly mortgage payments
may also go down. ARMs are
attractive because they may
initially offer a lower interest
rate than fixed-rate mortgages.
Since the monthly payments on an ARM
start out lower than those of a
fixed-rate mortgage of the same
amount, you can qualify for a larger
loan.
The chief drawback, of course, is
that your monthly payments may
increase when interest rates go up.
The types of people who typically
benefit from an ARM are those that
are planning to move or refinance in
the near future, people with a high
likelihood of increasing their
income in later years, and people
who need lower initial interest
rates on their mortgage to be able
to buy a home. How much your
payments can increase will depend on
the terms of your mortgage.
Before applying for an ARM, be sure you know
how high your monthly payments could go -
the so-called "worst-case scenario." An ARM
has two "caps" or limits on how large an
interest rate increase is permitted: One cap
sets the most that your interest rate can go
up during each adjustment period and the
other cap sets the maximum total amount of
all interest adjustments over the life of
the loan. The rates on an ARM usually change
once or twice a year, and there is typically
a lifetime rate cap (or limit) on both the
amount of each individual rate adjustment
and the total amount the rate can change
over the whole term of the loan. For
example, if your loan starts at 5 percent,
has a 2 percent per-adjustment cap, and a
lifetime adjustment cap of 4 percent, you
know that your loan might go up to 7 percent
the first time the rate changes. You also
know that the rate can never go over 9
percent over the life of the loan (5 percent
start plus 4 percent lifetime cap). Only you
can determine if you would feel comfortable
paying this interest rate sometime in the
future.
Some ARMs offer a conversion feature, which
allows you to convert from an
adjustable-rate to a fixed-rate loan at only
certain times during the life of your loan.
Ask your lender about this feature when
researching ARMs. One important thing to
know when comparing ARMs is that the
interest rate changes on an ARM are always
tied to a financial index. A financial index
is a published number or percentage, such as
the average interest rate or yield on
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