Keywords: Mortgage, Fixed-Rate, Variable-Rate, Interest-Only, Balloon Payments
One of the most important decisions you will make when you buy a new home is how to structure your mortgage. It is vitally important to make sure that the amount you pay in principle, interest, taxes and insurance- referred to as PITI- is within your comfort zone so you don’t find yourself struggling to make house payments or facing foreclosure. In order to make sure your payments are affordable not only today, but also in the future, understand how the different mortgage options for home purchases are structured and choose the one that is right for you.
The Fixed-Rate Mortgage
The fixed-rate mortgage has long been the staple of the mortgage industry and is the safest option you have for taking a mortgage on your home. When you take on a fixed-rate mortgage, your interest rate is set for the life of the loan. This means that your principle and interest payment will never change. Although your taxes may go up if your county changes the rules, you can be reasonably assured that your payments will not increase dramatically. You can be confident that you’ll always be able to afford the house as long as your income remains stable or goes up.
When you opt for a fixed-rate mortgage, you have several different choices as far as the mortgage term. The two most common options are 15-year mortgages and 30-year mortgages. A 15-year mortgage carries a lower interest rate, but the payments are higher because you are paying off the entire loan balance in half the time. A 30-year mortgage has a slightly higher rate but is still an excellent option for most homeowners and was long considered the standard.
In some cases, mortgages may be extended for terms as long as 40 years. While this can allow you to have lower payments and buy a more expensive home, it results in you paying more in interest charges.
The Adjustable Rate Mortgage
Adjustable rate mortgages are an alternative to fixed rate mortgages that became popular during the housing boom leading up to the 2008 crash. Adjustable rate mortgages offer an introductory “teaser” interest rate that is locked in for a period of time and that is very low. With the low interest rate, payments become correspondingly low and many people are able to buy a lot more house than they otherwise would be able to afford.
The problem with adjustable rate mortgages is that eventually, the introductory teaser interest rate period ends and the mortgage begins to adjust. This almost always means it adjusts upward- and sometimes by a lot. When the interest rate on an adjustable rate mortgage starts to go up, sometimes the payments can become too much to afford, putting you at risk of losing your house.
If you are 100 percent sure you’ll be moving within the time before the teaser interest rate ends, or if you are confident you can refinance the mortgage into a lower rate mortgage when the time comes, adjustable rate mortgages can work. Before choosing this option, however, be sure you understand the risk. You also cannot assume that your income will always go up or that property values will always go up, so be aware that refinancing may be at trickier proposition than you’d hope.
Other Financing Options – Trouble By Another Name
While adjustable and fixed-rate mortgages are the two primary options available in the mortgage market, there are a whole host of other creative means of structuring a mortgage. Most of these are used to help people who can’t quite afford to buy a house stretch their budgets in order to get into one. This often makes them dangerous products that can get you in financial trouble.
One example, for instance, is the balloon mortgage. A balloon mortgage allows you to make payments for a period of time after which the entire balance of the mortgage will be do in one lump sum. The idea is that when the balloon payment is due, you will be able to refinance. Unfortunately, this isn’t always possible and many people are left unable to pay the large payment and struggling not to lose their houses. Balloon payments may also be structured as interest-only mortgages during the period before the lump sum payment is due, which means you won’t be paying anything down on the principle at all and will just be paying the interest.
Before you choose any type of financing option- whether creative or conventional- it is essential to understand exactly what you are getting into so you don’t get in over your head.