How to Choose The Best Mortgage

Once the size of the mortgage that you can afford has been determined, ( if you have not qualified for a Government Loan or other special situation) the next actions are to select :

1.    The Variety of Mortgage:  Adjustable-rate or fixed-rate mortgage

2.    The Term of the Mortgage:  15-year or 30-year term

Fixed-Rate vs. Adjustable-rate Mortgage Loans:

The most important issue when deciding between a fixed-rate mortgage or an ARM is the length of time you plan to spend living in the property.

• In the case you plan on living in the property for more than 5-7 years:  A fixed-rate mortgage is typically the better alternative.  The reason for this is that the majority of ARMs begin to modify interest rates after 5-7 years.  Having a fixed-rate mortgage will protect you from the probability of having to pay higher rates.
• In the case that you plan to sell the property within those 5-7 years:  You would likely benefit from the low initial interest rates on an ARM without having to be concerned with the risk of altering interest rates in the event that you sell the property prior to the expiration of the initial fixed-rate term of the mortgage.  However, if you do decide to go with an ARM for this reason, you really will need to be able to sell the property before the fixed-rate expires, or you will be left to deal with the adjusting interest rate and the change in payment price that goes along with that.

The Affordability Trap of ARMs

Potential home shoppers frequently look to ARMs as a means to make a dream home “affordable”.  They choose to go with an ARM because they are comfortable with the ARM’s smaller monthly payments, without taking any consideration as to whether they will be able to afford the higher payments they are likely to experience when the fixed-rate period of the ARM concludes.  In order to avoid this trap, only choose an ARM if you are completely certain that you will be able to afford your payments even if they increase to the largest potential amount following a rate adjustment.

15-Year vs. 30-Year Mortgages

The extent of a mortgage’s terms affects both the monthly payment price as well as the total cost of the mortgage.

• Lower length mortgage terms result in an overall lower cost: Since there is less interest accumulated over time, short-term mortgage loans provide a lower overall cost than long-term mortgage loans.
• Lengthier mortgage terms equate to smaller monthly payments: Since these mortgages span a greater length of time, lengthier-term mortgages provide lower monthly payment options than do short-term mortgage loans.

The following table compares monthly payments and overall cost for two mortgages having the same principal ($100,000) and interest rate (6%), but having terms of 15- and 30-years.

Which Term Should You Select?

You should choose either a longer- or shorter-term mortgage based on your specific financial circumstance.  If there will be no difficulty in handling the higher monthly payments of a shorter-term mortgage, that would likely be the best direction to go.  However, if you are unable to afford the higher monthly payments associated with a shorter-term loan, a longer-term loan would be a better selection for you.