Home buyers can choose from many different types of mortgages. The basic models are fixed rate mortgages and adjustable rate mortgages or ARMs. More choice is created when lenders vary the term of the loan, the way the principal amount you owe is paid off or amortized, or add features such as a conversion option or prepayment privilege.
“In addition to the traditional 30-year fixed rate mortgage, there are dozens of mortgage loan products available, from adjustable rate mortgages to interest-only and negative amortization loans,” says LendingTree Chief Consumer Officer Ed Powell.
The factors you should take into account when choosing your mortgage include:
- What you can afford to pay each month based on your current income.
- Whether you expect your income to rise, fall or stay the same over time.
- Whether you plan to stay in the house long-term or move in a few years.
- Your tolerance for risk.
- Whether you expect interest rates to rise, fall or stay about the same.
Taken together, these factors narrow the range of mortgages that you should consider.
Take this scenario: you and your partner both earn good money and expect your salaries to rise. You plan to move in three to five years and expect interest rates to stay about the same or even fall during that period.
Under these circumstances, you might choose a fully amortized five-year ARM or fixed rate loan with pre-payment options.
A five-year mortgage is a good choice because the term matches the length of time you expect to own the house. If you sell after three years, your early redemption penalty will be minimal. If you decide not to move, you can refinance when the mortgage matures.
A fully amortized loan with prepayment options allows you to pay down the principal amount you owe and build equity quickly – a good idea for anyone who can afford it.
An adjustable rate loan might suit you if you are confident that interest rates are on their way down. But if you don’t like taking any risks, you’ll probably want to protect yourself against the possibility that rates will increase by taking a fixed rate loan.
Here’s another, quite different, scenario that leads to a different mortgage choice: your income is low and/or fixed. You plan to stay in your home for many years, and expect interest rates to rise.
You will likely choose a traditional 30-year fixed rate mortgage. The 30-year term and fixed rate allow you to lock in affordable monthly principal and interest payments for the long term. You know your installments will be manageable, and you will be chipping away at the principal of the loan and building equity slowly but steadily.
With all the options available, there’s bound to be a mortgage that suits you and your situation. Powell suggests you talk to a loan officer at your bank about the choices. “Taking the time to learn about the process is worth it, because you’ll be a better advocate for yourself,” he says.