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Understanding and selecting the right mortgage to fit your circumstances can save you thousands of dollars. Many people consider a fixed rate mortgage the safest way to go.
One of the first things to consider after deciding to purchase a house is what type of loan and terms are best suited for your situation. There are two main categories of mortgage loans, fixed and adjustable rate, and many variations within these two categories. Your choice will affect the total amount of a mortgage loan for which you will qualify and the amount of your monthly mortgage payment. Generally your monthly house payment, including property taxes and homeowner's insurance, should not exceed about 30% of your gross monthly income. There are three variables that affect your monthly payment amount: the interest rate, the term, and the loan amount.
The main appeal of a fixed rate mortgage is that you know exactly what your mortgage payment will be for the life of the loan. If interest rates rise, your mortgage payment will remain constant. If rates drop in the future, you always have the option of refinancing. Fixed rate mortgages are also an attractive choice for buyers who expect a steady (not climbing) source of income. The disadvantage is that fixed rate mortgage loans tend to have a higher interest rate than the prevailing rates for adjustable rate mortgage loans. This means that when your principal and interest payment (P & I) is calculated, it will be higher, and you may not be able to afford as much house.
The two most common fixed rate loans have terms of 15 or 30 years. There are also 20-year terms and, recently, 40-year terms have become available. Carefully evaluate the financial impact of the term you consider. For example, let's compare the difference in the monthly payment and the total interest paid on a $100,000 mortgage at 8% interest.
|Length Of Term||Monthly Payment||
Total Interest Paid
Through End of Term
40 - year: As the illustration shows, while the 40-year loan provides a lower monthly payment, the higher amount of interest you will pay over the 40 years makes it a more expensive proposition for the moderate monthly savings over a 30-year mortgage payment. Don't forget that the longer the term, the longer you will have a mortgage payment, and the longer it will take to own your home.
30 - year: Thirty-year mortgages are the most traditional and are a popular choice for first time homebuyers who may need a stable monthly payment. The interest rate on a 30-year mortgage is typically a half percent higher than a 15-year mortgage, but you can shorten the term by simply making extra principal payments. This may be a good choice if you expect to stay in your home for a long time and want the flexibility that a lower mortgage payment provides. Because the payment is lower when spread out over a longer term, this option may also allow you to qualify for a higher loan amount.
15 - year: 15-year mortgage may be a good choice if you expect to stay in your home for a long time and have the cash flow to afford the higher monthly payment. The main benefit of this shorter term is that the amount of interest you pay over the life of a 15-year mortgage is almost half of what you pay on a 30-year mortgage, plus you'll own your home free and clear in half the time. To help you choose what type of mortgage is best for you, see the Federal Reserve Board publication Looking for the Best Mortgage. Use the CareOne Credit Calculators to help you compare 15-, 30-, and 40-year mortgages.
Everyone's situation is unique. You may want to go with a longer-term mortgage to take advantage of the tax deduction available on mortgage interest, and invest the monthly savings a 30-year mortgage payment affords. If you're closer to retirement age and more conservative with your investments, you may want to take advantage of the guaranteed savings the lower interest on a 15-year term offers. Be aware of your options, analyze your personal situation, and don't be afraid to ask your loan officer to explain your options. CareOne Credit can help you design a debt management solution.
Avoid surprises! Be prepared for closing costs when it's time to finalize your loan.
Homeowner's insurance protects you when your dream home meets disaster. It could happen to you so make sure you have the right coverage.
The lower interest rate of an Adjustable Rate Mortgage (ARM) may be enticing. Just make sure you know all the details before you make a decision.
If you are thinking of buying a house, gain some bargaining power before you start house hunting by first getting pre-approved by a mortgage lender.
So you have found the house of your dreams. Now what? Know the mortgage process before you apply for a loan and avoid any unpleasant surprises.
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