Buying a home is one of the most important decisions you can make in your life – and part of that includes making the financial commitment to a mortgage. That’s why choosing the right type of mortgage loan can make a big difference to your home buying experience – and beyond, as your mortgage loan choice can affect everything from the overall cost of your loan to your monthly payments.
As you’re considering types of mortgage loans, talk with your lender and do some research on the different types of loan options you have available to you. You may also want to talk with a certified housing counselor to help you make your decision.
The two main types of mortgage loans that are available to you as a buyer are a fixed-rate and an adjustable-rate mortgage, which each have their own list of features and benefits that could be of great service to you, depending on your needs and financial goals.
Let’s look at a fixed-rate mortgage first.
Fixed-Rate Mortgages: One of the key benefits to a fixed-rate mortgage is inflation protection, so that if mortgage rates increase at any point in the future, yours will remain the same. However, there are other benefits to fixed-rate mortgages, including:
- They offer affordability, stability and flexibility.
- Choosing one with a 15-year term will have a higher monthly payment, but you’ll build equity in your home faster.
- Your interest rate will be locked for the life of the loan, no matter the lifetime of your mortgage.
This is the most common type of mortgage homeowners choose, with nearly 90% of buyers opting for the 30-year fixed-rate mortgage.
However, there are some points of a fixed-loan mortgage that should be considered, including:
- If interest rates go down, you may want to consider refinancing your mortgage if it makes good financial sense.
- Your payment can increase based on changes to taxes and insurance.
If you choose to go for a fixed-rate mortgage, it’s likely your lender will present you with a 15 or 30-year term (though some offer 20-year options as well.) Each term tends to break down as follows:
- A 30-year term will give you a lower monthly payment, as payment will be spread over a longer period of time. However, your interest rates tend to be higher.
- Conversely, a 15-year term has higher monthly payments, but you can build your home equity faster and pay less interest – both due to the length of the loan, and that interest rates tend to be lower.
Now let’s look at an adjustable-rate mortgage.
Adjustable-rate Mortgages: If you’re considering an adjustable-rate mortgage – or, ARM – the most important thing to know is that your payment may go up over time. However, if you don’t plan to live in your home for very long and suspect you may leave before the adjustment period, an ARM may be the most sensible choice. Some things to know about ARMs:
- ARM interest rates on a 3/1 may change after three years, then once a year for the remainder of the loan.
- ARMs may start out with lower monthly payments than a fixed-rate mortgage, but payments will go up over time.
- If interest rates fall, your payments may not go down.
- If you choose to pay off the loan early, you may incur penalties.
ARMs begin with an adjustment period that map out the change in interest rates. There’s an initial period where there is no change, which can range from six months to 10 years, depending on the life of your loan. However, after that initial timeline is up, your ARM will adjust. Most ARMs begin with a three, five or seven-year adjustment period. Most ARMs usually have an adjustment cap, which can limit how much the interest rate can fluctuate during each period.
As you continue to move forward with your home purchase and put serious thought into your mortgage options, make sure you discuss each option with your lender to help determine which one best suits your financial goals.