Home financing: the basics.
Mortgages can seem like a swarm of numbers; but no fear. Home financing need not be intimidating; you just need to have a sense of what works best for your needs. Certainly you should speak to an experienced home lender about these topics—getting pre-approved before coming to talk to realtors is key! But in the meantime, here is the lowdown on what you need to know about mortgages.
Types of mortgages
There are two main types of mortgage: fixed-rate and adjustable-rate.
Fixed-rate mortgages, as the name would suggest, have the same interest rate through the life of the loan. Generally speaking, the higher the borrower’s credit rating, the lower the interest rate, as such borrowers present a lower risk to the lender.
The benefit is that you know exactly how much your payment will be and the interest rate cannot change for the life of the loan. A downside is that if you see yourself making more money later in your career, initially your monthly payment will comprise a higher percentage of your income.
Fixed-rate mortgages have different amortization periods. The most common is a 30-year fixed rate mortgage, although 15-year and 20-year mortgages are also available. The major pro to a shorter mortgage period is obvious: your home will be paid off more quickly. The tradeoff is that you’ll have higher monthly payments. Plus since you’ll be paying more toward the principal of the loan rather than interest, you’ll build up home equity that much faster.
For homeowners intending to stay in their home for longer periods of time, a fixed-rate loan is recommended.
Adjustable-rate mortgages, or ARMs, are exactly as they sound. The rate is fixed for the initial period—say five years—then increases annually. There is a cap on the maximum possible monthly payment.
The most common ARMs are for three-, five-, seven- and 10-year terms. Borrowers usually refinance after the end of the fixed period. Benefits to securing an ARM are the lower initial rates and payment. Thus if a borrower is planning on either selling or paying off the loan and just needs it for a short period, an ARM might be a worthwhile financing choice.
Points are a percentage of the total mortgage amount. One point equals 1% of the loan. They can be used to buy down a rate. For example, borrowers usually have the option of either paying a rate with no points, or pre-pay points to the bank in order to secure a better financing rate. This means their monthly payments will be lower throughout the life of the loan. A financing expert can explain to a borrower whether it is worthwhile to purchase points.