Learning about the types of mortgages available and choosing among them is the first step in getting the best mortgage.
Your choice of mortgage program depends on your goal, the number of years you expect to keep your home, and your finances. If you plan to move in five-to-seven years (which is the most common time frame), for example, you can choose from several home loans:
- 30-year fixed mortgage
- 15-year fixed home loan
- Adjustable rate mortgage (ARM)
- Hybrid ARMs, fixed for 3, 5, 7 or 10 years
The 30-year Fixed Mortgage
This old-school,safe loan is exceptionally stable because your interest rate and payment do not change during its life. It has a lower payment than 15-year fixed loans, because repayment is extended over three decades. However, the 30-year mortgage carries the highest interest rate. The 30-year mortgage is not common outside of the US, and many believe this loan is the main reason for America’s high home ownership rate.
The 15-year Fixed Mortgage
The 15-year home loan, like its 30-year counterpart, has an unchanging rate, and that rate is usually .5 percent to .75 percent lower than comparable 30-year mortgage rates. Because you pay your home off in half the time, your payments are larger (but not twice as large) and you pay much less interest over the loan’s lifetime. For example, if you refinance a $200,000 mortgage at 3.5 percent for 30 years, your principal and interest payment is $898. With a 15-year loan at 3.0 percent, your payment is $1,382 – about 1.5 times higher.
Adjustable Rate Mortgages (ARMs) and Hybrid ARMs
An adjustable rate mortgage may have a very low initial rate (also called a start rate, introductory rate or teaser rate). That rate can move as changes occur in global financial markets. It can increase or decrease over time. ARMs have a safety valve for borrowers — caps that limit how much the interest rate can increase at any single adjustment, and caps that limit how high the rate can go over the life of the loan. One common set of limitations is that the rate can’t increase by more than two percent per year, and that it can never be more than six percent over the start rate. ARMs may also have floors, which protect the lender by limiting how low the rate can go over the loan’s life.
Hybrid ARMs like the 3/1, 5/1, 7/1 and 10/1 offer rates that are fixed for three, five, seven or ten years. The start rates can be much lower than those of 30-year or 15-year mortgages, and this could save you a lot of money. For example, if you buy a home that you expect to keep for about five years, you might be offered a 30-year loan at 4.00 percent, a 15-year loan at 3.25 percent, a 5/1 loan at 2.75 percent and a 1-Year ARM at 2.5 percent.
Here’s what your payments and costs would be over a five year period:
The picture would look quite different, though, if you planned to keep the property for ten years. To get the best interest rate possible, then, you really need to know yourself and be fairly certain about your plans for the next few years.