Best Type Of Mortgage Loan For First Time Home Buyers – Fixed rate mortgages and adjustable rate mortgages (ARMs) are the two primary types of mortgages. Although the market offers many types in these two categories, the first step when shopping for a mortgage is to decide which of the two main loan types best suits your needs.
A fixed-rate mortgage charges a fixed interest rate that doesn’t change over the life of the loan. Although the amount of principal and interest paid each month varies from payment to payment, the total payment remains the same, making it easier for homeowners to budget.
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The breakdown of partial amortizations below shows how the amounts invested in principal and interest change over the life of the mortgage. In this example, the mortgage term is 30 years, the principal is $100,000, and the interest rate is 6%.
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As you can see, the payments made in the first few years of the mortgage consist mainly of interest payments.
The main advantage of a fixed rate loan is that the borrower is protected from a sudden and potentially significant increase in monthly mortgage payments if interest rates rise. Fixed rate mortgages are easy to understand and vary little from lender to lender. The downside to fixed rate mortgages is that when interest rates are high, it is more difficult to qualify for a loan because payments are less affordable. A mortgage calculator can show you the effect of different rates on your monthly payment.
Although the interest rate is fixed, the total amount of interest you pay depends on the term of the mortgage. Traditional lending institutions offer fixed-rate mortgages for a variety of terms, the most common of which are 30, 20 and 15 years.
A 30-year mortgage is the most popular option because it offers the lowest monthly payment. However, the trade-off for this low payment is a significantly higher total cost, as the next decade or more in this period is devoted primarily to interest payments. The monthly payments for shorter mortgages are higher so that the principal is paid off in a shorter time frame. Shorter-term mortgages also offer a lower interest rate, allowing you to repay a larger amount of principal with each mortgage payment. Short-term mortgages therefore cost significantly less overall. (For more information, see Mortgage Payment Structure Explained.)
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The interest rate on an adjustable rate mortgage is variable. The initial interest rate on an ARM is set below the market rate for a comparable fixed-rate loan, and the rate increases over time. If the ARM is held long enough, the interest rate will exceed the standard rate for fixed-rate loans.
ARMs have a fixed period during which the initial interest rate remains constant, after which the interest rate adjusts at a pre-MSMD frequency. The period of fixation can be significantly different – from one month to 10 years; Shorter adaptation periods generally mean lower initial interest rates. After the initial period, the loan resets, meaning there is a new interest rate based on current market rates. That’s the rate until the next reset, which could be next year.
ARMs are significantly more complicated than fixed-rate loans, so exploring the pros and cons requires understanding some basic terminology. Here are some concepts borrowers should know before choosing an ARM:
The biggest advantage of an ARM is that it is significantly less expensive than a fixed mortgage, at least for the first three, five or seven years. ARMs are also attractive because their low initial payments often allow the borrower to obtain a larger loan, and in a falling interest rate environment, allow the borrower to take advantage of lower interest rates (and lower payments) without refinancing the mortgage. .
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A borrower who opts for an ARM can save several hundred dollars per month for up to seven years, after which their costs are likely to increase. The new rate will be based on market rates, not an initial below-market rate. If you are very lucky, it may be lower depending on what the market rates are at the time of the rate change.
However, ARM can present some significant disadvantages. With an ARM, your monthly payment can often change over the life of the loan. And if you take out a large loan, you could be in trouble when interest rates rise: Some ARMs are structured so that interest rates can nearly double in a few years. (See more
Adjustable mortgages really fell out of favor with many financial planners after the subprime mortgage meltdown of 2008 ushered in an era of foreclosures and short sales. Borrowers faced sticker shock when their ARM adjusted and their payments skyrocketed. Fortunately, government regulations and legislation have since been put in place to increase the oversight that turned the housing bubble into a global financial crisis. The Consumer Financial Protection Bureau (CFPB) prevents predatory mortgage practices that harm consumers. Lenders lend to borrowers who are likely to repay their loans.
When choosing a mortgage, you need to consider a wide range of personal factors and balance them with the economic realities of an ever-changing market. Individuals’ personal finances often experience ups and downs, interest rates rise and fall, and the strength of the economy waxes and wanes. To put your loan selection in context with these factors, consider the following questions:
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If you are considering ARM, you should run the numbers to determine the worst case scenario. If you can still afford it, if the mortgage resets to the maximum cap in the future, the ARM will save you money every month. Ideally, you should use the savings compared to a fixed-rate mortgage to pay off the principal every extra month so that the total loan after reset is smaller,
If interest rates are high and expected to fall, an ARM ensures that you take advantage of the drop because you are not locked into a specific rate. If interest rates are rising or a stable and predictable payment is important to you, a fixed rate mortgage may be the way to go.
An ARM can be a great option if your primary requirement is low payments in the near future or if you don’t plan to live in the property long enough for the rates to increase. As mentioned earlier, the term of a fixed rate ARM varies, typically from one year to seven years, which is why ARMs may not make sense for people who plan to keep their home longer. However, if you know you’ll be moving in the short term, or don’t plan on keeping the house for decades to come, an ARM will make a lot of sense.
Let’s say the interest rate environment means you can take out a five-year ARM with an interest rate of 3.5%. In comparison, a 30-year fixed-rate mortgage would give you an interest rate of 4.25%. If you plan to move before the five-year ARM resets, you’ll save a lot of money in interest. On the other hand, if you end up staying in the home longer, especially if rates are higher when your credit is modified, the mortgage will cost more than a fixed rate loan would. However, if you’re buying a home with an eye toward upgrading to a bigger home once you start a family—or think you’ll be moving for work—then an ARM may be right for you.
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For people who have a stable income but don’t expect it to increase dramatically, a fixed mortgage makes more sense. However, if you expect to increase your income, switching to an ARM can save you from paying a lot of interest in the long run.
Let’s say you’re looking for your first home and you’ve just graduated from medical or law school or earned your MBA. There is a good chance that you will earn more in the coming years and you can afford increased payments as your loan adjusts to a higher rate. In this case, ARM will work for you. In another scenario, if you expect to receive money from Atrustat at a certain age, you can get an ARM that resets in the same year.
Applying for a mortgage with an adjustable interest rate is very attractive to mortgage borrowers who have or will have the money to repay the loan before the new interest rate kicks in. Although this does not include the vast majority of Americans, there are situations in which it may be possible to withdraw.
Consider a borrower who buys one house while selling another. The person may be forced to buy a new home while the old one is under contract, and as a result take a year or two off ARM. Once the borrower has the proceeds from the sale, they can turn around and repay the ARM with the proceeds from the sale of the home.
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Another situation where an ARM would make sense is if you can afford to accelerate the payments each month enough to pay it off before it resets. Using this strategy can be risky because life is unpredictable. Although you can afford accelerated payments now, if you get sick, lose your job or the boiler goes out, this may not be an option.
No matter what type of loan you choose
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