Finding a mortgage that fits your life

If you’re shopping around for a mortgage or other loan, you’ve got a dizzying variety of products to pick from. The choices can be confusing, but the good news is that with a little careful planning you should be able to find a product that meets your own particular needs.

There’s one thing all good loans have in common: a favorable interest rate. Remember, however, that the rate you’re quoted may not tell the whole story. Is the interest rate fixed for the life of the loan, or can it change? Are there closing costs, points or other charges tacked on? Make sure you ask for the loan’s annual percentage rate (APR), which adds up all the costs of the loan and expresses them as a simple percentage. Lenders are required by law to calculate this rate using the same formula, so it’s a good benchmark for comparison.

The features of your loan -- which may be buried in small print -- are just as important. A favorable adjustable-rate loan, for example, protects you with caps, which limit how much the rate and/or monthly payment can increase from one year to the next. Ask whether a mortgage carries a prepayment penalty, which may make it expensive to refinance. And don’t be seduced by low monthly payments -- some of these loans leave you with a large balloon payment due all at once when the term is up.

None of these features are inherently bad, but some do involve risks that can be dangerous if you don’t understand them. The key to choosing the right loan is weighing the pros and cons of each, and then deciding which fits your circumstances. Let’s look at a few examples:

Case 1: You’re buying your first house, where you expect to stay for three to five years. You would like the lowest rate you can get, even if it means accepting a little risk.

You may want to choose an adjustable-rate mortgage (ARM), since these usually carry lower rates than fixed-term loans. If there’s a chance you’ll stay more than five years, you might also consider a hybrid mortgage. This has a fixed rate for a specified number of years -- in this case, you’d choose a three- or five-year term -- after which the rate gets adjusted upward or downward annually based on current rates.

Case 2: You’ve just had a second child and are looking to move into a larger house. You plan to stay put for at least 10 years, and you don’t want to be sweating about swings in interest rates.

You should likely choose a fixed-rate mortgage. In the short term, you’ll pay more than you would with an ARM, but since you’re in for the long haul, you’ll enjoy the stability that comes from a consistent rate and payment. If you can afford the higher payments, a loan with a 20-year term will build equity more quickly than one with a 30-year term.

Case 3: You bought your home with 20 percent down eight years ago and you’re planning a $30,000 renovation. You can comfortably afford to make a second loan payment on top of your existing mortgage.

You might want to consider a home equity loan or line of credit for $30,000, since securing the loan with your property will give you the lowest possible interest rate. If your first mortgage doesn’t have a prepayment penalty, you might instead think about getting a new mortgage with a principal that is $30,000 higher. This is called cash-out refinancing and has the benefit of carrying just one payment each month rather than two. Your total payments may be lower as well, because usually the interest rate on a first mortgage is lower than the rate on a second mortgage or home equity loan.

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