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Choosing a Mortgage

Choosing among the many houses that may be available is hard enough--then you need to make a choice from the myriad of mortgages that are offered in today’s market. So many decisions! Take heart, though, since although there are literally hundreds of different mortgages available, they all fall into only a few basic varieties. Some may fit perfectly into your situation, others may be unwise or unattainable. By narrowing your choices, the process of picking the right mortgage becomes much easier.

Fixed Rate or Adjustable?

One of your first decisions should be between a fixed rate (the interest rate remains constant through the life of the mortgage) or an adjustable (the interest rate is adjusted--either up or down--at specified times during the mortgage term). Adjustable Rate Mortgages (ARMs) will have an initial interest rate lower than fixed rates but will adjust upward (unless rates really fall!) usually after the first year. They may be a good choice if you are sure that you will not be owning the home for an extended period (more than 5-7 years) of time.

Advantages and Disadvantages of Fixed and ARM Mortgages

Advantages--Fixed
* Since you know what your payment will be for the life of the loan, you can budget more easily.
* No possibility of an interest rate change making your mortgage payment suddenly unaffordable.
* No anxiety over interest rate fluctuations.

Disadvantages--Fixed
* More income needed to qualify because of higher initial mortgage rate.
* If interest rates decrease appreciably, it will be necessary to refinance to get a lower payment.

Advantages--ARM
* Lower initial interest rate and therefore lower monthly payment.
* If interest rate declines, your payment will also decline.
* Easier to qualify for due to lower initial interest rate and payment amount.

Disadvantages--ARM
* If interest rate increases, your payment will also increase.
* A large increase in interest rates--and payment--could make your house unaffordable.

Terms: 15, 20 or 30 years

You will probably want to shoot for the shortest term that is comfortable (and for which you will qualify). The interest savings are enormous as the term decreases. Always make a comparison between a 15 year term payment and a 30 year term payment. The difference is often surprisingly smaller than anticipated. The savings over the term of the loan, however, can be substantial. For example, comparing a 15 year term to a 30 year term, $100,000 mortgage at an 8 1/2% fixed rate yields the following results.

Principal and Interest Payment (per month)

15 Year: $985

30 Year: $769

Total paid over term in P&I

15 Year: $177,300

30 Year: $276,840

Total interest over term

15 Year: $77,300

30 Year: $176,840

HINT: If you can’t qualify for a shorter term try to add at least the amount of 1 additional payment per year--this will knock nearly 10 years off a 30 year loan.

Common Loan Types: Conventional, FHA, VA and “No-Document”

Conventional: A “traditional” mortgage, not directly insured by the Federal Government. Most conventional loans under $275,000 are administered through Fannie Mae or Freddie Mac (private corporations but regulated by the government). Those loans over that amount are designated “jumbo loans” and are funded by the private investment market.

FHA: Insured by (but not funded by) the Federal Housing Administration (FHA) a division of the U.S. Department of Housing and Urban Development (HUD), and designed for, in general, low- and middle-income borrowers and many first-time buyers. There are, however, limits (which vary from county to county) to the maximum loan amount. On January 1, 2000 HUD began insuring home mortgage loans of up to $121,296 in communities where housing costs are relatively low, and loans ranging up to $219,849 in communities where housing costs are relatively high. FHA loans have somewhat more relaxed qualifying standards and ratios than conventional loans and have the availability of both 15 and 30 year fixed as well as 1 year adjustable mortgages.

VA: For those qualified by military service, the Veterans Administration (VA) insures (but does not fund) 15 and 30 year fixed as well as 1 year adjustable mortgages with lower down payment requirements (as low as 0 down) and somewhat more lenient qualifying ratios.

No-Document ("No-doc) Loans: No-doc mortgages are generally a wise choice for self-employed people, those who do not wish to verify their income, and those with a brief or blemished credit history, or no credit. The benefits of a no-doc mortgage include a shorter application process since you are not required to provide income, employment or asset documentation, as well as a streamlined approval process because there is little subsequent verification. However, no doc mortgages generally will be at slightly higher interest rates and are offered by fewer lenders.

Points or No Points

A large component of your mortgage decision has to do with one of the first charges associated with your loan--even before you make your first payment--the “points” attached to the mortgage. A point is 1% of the loan amount, paid to the lender or the mortgage broker at closing (in cash). For more information on paying (or not paying) points, see the article “Should I Pay Points?” written by Randy Johnson, author of the best-selling book on mortgages How to Save Thousands of Dollars on Your Home Mortgage.

Mortgage Comparisons

Once you have a general idea of the type of mortgage that best suits your situation, the next step is to begin to make comparisons among the lenders that are available. Weekend newspapers will often have the rates of individual local lenders posted in their Real Estate section. To get the specifics of each lender’s rate and term, you can contact the bank or mortgage company directly. Another source is a mortgage broker in your area, who will often represent a number of sources of mortgage funds and can assist you in your choice.

This article courtesy of The Home Buyer’s Information Center, a complete guide to buying a home. 2002