Over the next few weeks we are going to discuss mortgages. When all the posts in the series are complete, you should have an understanding of mortgage types, structure, rates, points, fees, mortgage insurance, and refinancing. To start with, let’s go over the most common types of mortgages you’ll come across when buying a house.
- 1 – Common Types of Mortgages
- 2 – Mortgage Structure, What is PITI?
- 3 – Interest Rate vs APR
- 4 – Origination Fees and Closing Costs
- 5 – Discount Points
- 6 – Private Mortgage Insurance (PMI)
- 7 – Refinancing
Common Types of Mortgages
- 30 Year Fixed Rate
- 15 Year Fixed Rate
- Adjustable Rate Mortgage
30 Year Fixed Rate Mortgage
$200k loan at 4% would cause you to spend $344k at the end of 30 years and $266k at the end of 15 years. Even though it’s only twice the time to pay it off, it costs 2.2 times more.
Pros This is the most popular type of mortgage used today. It’s definition is in the name. Over the next 30 years you are going to pay a fixed interest rate. It’s stable because you don’t have to worry about your payments changing over the life of the loan. Out of the two fixed rate mortgages, 30 year terms are appealing due to a lower monthly payment. People also tend to get approved for a higher loan amount due to the payments taking up less of their income.
Cons It’s important to note that even though you’re paying less per month, the longer period of time results in more money paid at the end of the term. The reason you get approved for a higher loan amount is because you are spending 3 decades to pay off your loan. You also end up with a higher interest rate as the risk the bank is taking is higher.
15 Year Fixed Rate Mortgage
Pros The biggest perk to a 15 year is the fact you’ll pay your mortgage off twice as fast. Imagine how wealthy you would be if you took your mortgage payment for the following 15 years and invested it! Top that off, you’ll have a lower interest rate and build equity in your home much faster.
Cons With this type of mortgage, you’ll have a higher monthly payment. So you have to choose to either get a less expensive home, or accept a higher payment. You’ll also most likely qualify for a lower loan amount as your debt to income ratio will be higher. But keep in mind, with realistic expectations and proper planning, the cons become a non-issue very quickly.
Adjustable Rate Mortgage (ARM)
Pros This is my opinion, but there really are no considerable pros to an ARM in the average home buyer’s circumstances. But if you can get a 4% rate with a fixed mortgage, you may get as low as 2.5% with an ARM. If you know that you can only be in the house for 3 or 4 years, then you get the low intro rate and sell the home before the balloon rate kicks in. But keep in mind, you may be playing with fire. What happens if in 4 years the market slows and you get stuck in your mortgage?
Cons ARMs are usually defined with numbers like 4/1 ARM or 5/1 ARM (one of the most popular). What this means is that for the first 5 years, you’ll have a low introductory rate. After that, your rate will adjust every year based on market conditions. Typically it can go up as high as 13%.
As for the fixed rates, they are the obvious choice for just about anyone else. Typically, the 15 year is the best option for someone who’s willing to buy less home than they could be approved for on a 30 year. There are some exceptions, like if you plan on living in the home for 8 years or less. You could have the lower payment and save, but keep in mind you’ll also have less equity.
At the end of the day, your best bet is talk to an experienced loan officer AND financial advisor when deciding what type of mortgage to go with. While the information in this article can give you some basic understanding and give you food for thought, an experienced professional will always be worth the time and money. ALWAYS seek professional advice before moving forward.