Whenever a person is ready to apply for a mortgage, they face a variety of options. Different lenders advertise different interest rates. There are many different mortgage terms, from an ARM of 5/1 to a fixed rate of 20 years. The options can seem almost overwhelming.
Fortunately, there are a few basic rules you can follow. Avoid variable-rate mortgages when you can, as you can be sure they will be adjusted when you least need them. A lower rate is not the final answer, as they often involve much higher upfront costs. Another useful rule of thumb? Do not choose the lowest monthly payment. It is rarely the best offer for you.
Generally, lenders offer a range of fixed-rate mortgages. Most lenders offer a 15 and 30-year mortgage. Some lenders supplement this amount with a 10-year, 20-year, and/or 40-year mortgage.
Each of these mortgage conditions has a specific interest rate, and generally, the lowest interest rate has the shortest term. A 15-year mortgage could have an interest rate of 3.5%, while a 30-year mortgage could have an interest rate of 4.25%.
Even with interest rate spreads that seem to favor the short term, lenders will tarnish the water by showing you your monthly payment. In most cases, the longest monthly mortgage payment is less than the shortest monthly mortgage payment. This lower monthly payment will be very tempting. But take a break for a second and look at the big picture.
First, multiply this monthly payment by the number of payments you will make. For example, if you are considering a monthly payment for a 30-year mortgage, look at 360 payments. If you are looking for a fifteen-year mortgage, you will see 180 payments. When multiplying, enter the number as the total amount you will pay the bank for the same house. What is the best offer?
Second, if you can only move with a long-term mortgage, you are in a dangerous situation. If you are trying to buy a house that is so expensive that you cannot make payments for a fifteen-year loan, you should not apply for the loan for any length of time. You just buy more than you can afford, and when something unexpected happens in your life, you are in a world of pain.
Finally, you will quickly capitalize on the short-term mortgage. In the first five years of a typical 30-year mortgage, you accumulate about 7% of the equity in your home. In other words, you still owe 93% of the face value of the mortgage. During the five-year period for a 15-year mortgage, you have accumulated about 20% of the equity in the home. In other words, you only owe 80% of the face value of the mortgage. What is the best situation when you suddenly have to sell your house for five years? Imagine that your local real estate market even drops by around 5%. If you can, get a short-term mortgage. In this way, you can save a lot of money in the long run.