This article is excerpted from a
publication of Fannie Mae
Copyright. Fannie Mae.
If you anticipate living in your home for many years, the
interest rate may be the main factor for you. If you expect
to keep the house for only a short period of time, the closing
costs may be more important to you. If you want to have
ended any mortgage debt by the time you are facing your
children's college bills or your own retirement, you may
wish to consider a shorter term loan such as a 15-year fixed-rate
mortgage. If your own retirement is years away, you may
be less inclined toward a shorter-term loan, preferring
to extend payments over a longer period of time through
taking on a 30-year mortgage loan.
How important to you is the certainty of a fixed mortgage
payment each month? If you want to make sure your mortgage
payment remains the same each month, then you'll want to
focus on various fixed-rate loans. If you are comfortable
with periodic changes to your mortgage interest rate, then
you may be inclined to consider adjustable-rate mortgages.
Fixed-rate mortgage loans
A fixed-rate mortgage ensures that your interest rate (and
your payments) will stay the same over the life of your
loan - which may be an important consideration if you plan
to stay in your home for several years. When you choose
the length of your repayment (usually 15, 20 or 30 years),
keep in mind that while shorter term loans may have higher
monthly payments, they also let you pay less interest and
build equity faster.
30-year fixed-rate mortgage loan
The advantage of a 30-year fixed-rate mortgage loan is that
it is the easiest to qualify for, and it gives you an excellent
opportunity to keep your mortgage payments reasonable by
making monthly payments over a long period of time. This
mortgage loan may be ideal if you plan to remain in your
home for years and wish to keep your housing expense low
and use any extra cash for other purposes. This loan also
provides maximum interest deduction for tax purposes.
20-year fixed-rate mortgage loan
The 20-year mortgage often offers a lower interest rate
compared to a 30-year loan. This mortgage amortizes principal
and interest over a 20-year period, 10 years less than the
traditional 30-year mortgage. This may save you a considerable
amount of total interest paid over the life of the loan.
15-year fixed-rate mortgage loan
The advantage of a 15-year mortgage is that its interest
rate is lower than a 30-year or 20-year mortgage. Such a
shorter-term mortgage will save you a significant amount
of interest over the life of the loan. By paying off the
mortgage more quickly, you also build up equity in your
home sooner. A 15-year mortgage can let you own your home
clear of debt earlier, which may be important if you are
approaching retirement or have other large expenses to cover
such as financing your children's education. However, the
monthly payments you make on a 15-year mortgage will cost
you more than those you would make on a 30-year or a 20-year
mortgage loan for the same total mortgage amount.
Adjustable-rate loans
With an adjustable-rate mortgage (ARM), the interest rate
you pay is adjusted from time to time to keep it in line
with changing market rates. This means that when interest
rates go up, your monthly mortgage payments may go up as
well. On the other hand, when interest rates go down, your
monthly mortgage payments may also go down. ARMs are attractive
because they may initially offer a lower interest rate than
fixed-rate mortgages. Since the monthly payments on an ARM
start out lower than those of a fixed-rate mortgage of the
same amount, you can qualify for a larger loan.
The chief drawback, of course, is that your monthly payments
may increase when interest rates go up. The types of people
who typically benefit from an ARM are those that are planning
to move or refinance in the near future, people with a high
likelihood of increasing their income in later years, and
people who need lower initial interest rates on their mortgage
to be able to buy a home. How much your payments can increase
will depend on the terms of your mortgage.
Before applying for an ARM, be sure you know how high your
monthly payments could go - the so-called "worst-case scenario."
An ARM has two "caps" or limits on how large an interest
rate increase is permitted: One cap sets the most that your
interest rate can go up during each adjustment period and
the other cap sets the maximum total amount of all interest
adjustments over the life of the loan. The rates on an ARM
usually change once or twice a year, and there is typically
a lifetime rate cap (or limit) on both the amount of each
individual rate adjustment and the total amount the rate
can change over the whole term of the loan. For example,
if your loan starts at 5 percent, has a 2 percent per-adjustment
cap, and a lifetime adjustment cap of 4 percent, you know
that your loan might go up to 7 percent the first time the
rate changes. You also know that the rate can never go over
9 percent over the life of the loan (5 percent start plus
4 percent lifetime cap). Only you can determine if you would
feel comfortable paying this interest rate sometime in the
future.
Some ARMs offer a conversion feature, which allows you
to convert from an adjustable-rate to a fixed-rate loan
at only certain times during the life of your loan. Ask
your lender about this feature when researching ARMs. One
important thing to know when comparing ARMs is that the
interest rate changes on an ARM are always tied to a financial
index. A financial index is a published number or percentage,
such as the average interest rate or yield on Treasury bills
