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Before you go shopping for a home, you should understand the types of mortgages that are available and how much money you can afford to borrow. Mortgages are available through many sources such as:
- Banks
- Credit unions
- Mortgage brokers
- Internet lenders
It is important to distinguish between two types of mortgages:
- Fixed-rate mortgages
- Adjustable-rate mortgages
Fixed-Rate Mortgages
With a fixed-rate mortgage, your interest rate remains the same for the life of the loan. If interest rates rise, you’ll be glad you have a fixed-rate mortgage.
Adjustable-Rate Mortgages
With an adjustable-rate mortgage or ARM, the interest rate adjusts according to an agreed-upon formula. When you sign up for an ARM, you risk that interest rates may rise and increase your monthly payment. It’s also possible that the interest rate will go down and your payment will be less. If interest rates are currently low, there is a greater probability that they will go up and your payment will be higher.
Other Mortgage Types
As home prices skyrocketed, mortgage lenders developed new products so new homebuyers would not be shut out of the marketplace. You might be offered a lower interest rate for the first five years of your mortgage or a loan where you only pay the interest for a set period. These mortgages presume that you’ll sell your house or find a different mortgage before the payments escalate.
There are even 40 or 50-year mortgages. Being married to your mortgage for decades longer isn’t necessarily a wise choice.
A $100,000 mortgage at 8.5 percent interest for 30 years has a monthly payment of $769. If you took out a 40-year mortgage at the same interest rate, your monthly payment would be $733. With the 40-year mortgage, the monthly payments aren’t that much smaller and you’ll be paying for 10 years longer. Over the life of the 40-year mortgage, you’ll pay $75,000 more than you would with the 30-year mortgage.
If you choose a mortgage with an exceptionally long term or an interest only loan, you make no progress toward paying off your mortgage. Even with a 25 or 30-year mortgage, very little of your monthly payment chips away at the principal during the first few years.
Shopping Around
As you shop around for the best deal on a mortgage, remember that interest rates are significantly different from lender to lender. A one percentage point difference on a $200,000 loan makes a difference of almost $50,000 over the life of your loan. Watch out for teaser rates that only last a few years.
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