Which Mortgage is Right for You and Why
MSN Monday today has an article on some common mortgages with brief discussions on which type of loan makes more sense under certain circumstance. The following are excerpts from article. I added the “What” section to give definitions of each loan type for easier read.
Buying for the long haul
- Loan: 30-year fixed rate mortgage.
- What: A 30-year fixed mortgage is “a loan that has an interest rate that stays the same for the 30-year term of the loan.”
- Why: “Financial peace of mind can be worth the higher interest rate that comes with an interest rate that won’t change for three decades.”
Job with good but inconsistent income
- Loan: Option adjustable rate mortgage (ARM).
- What: Option ARM is “an adjustable-rate mortgage that allows the borrower to choose from four types of payment each month.”
- Why: “Each month you have a choice of payments: the full amount needed to pay off principal and interest as scheduled, an amount that covers only the interest owed that month, or an even smaller amount that doesn’t even cover interest owed.”
Refinancing (15-20 years before retiring)
- Loan: 15- or 20-year fixed or ARM.
- What: ARM is a “home loan in which the interest rate is changed periodically based on a standard financial index. Most ARMs have caps on how much an interest rate may increase.”
- Why: “A fixed rate generally has a higher interest rate than an adjustable but will give you more certainty in budgeting. However, if ARMs are significantly cheaper and your income can handle possible payment increases, you could save with the adjustable rate.”
Recent graduate with strong earnings potential
- Loan: One-year ARM.
- What: A 1-year ARM is “an adjustable-rate mortgage (ARM) that has an initial interest rate for one year, and thereafter has an adjustment interval of one year.”
- Why: “Stretch your dollars with low interest rates during the years when your income is at its leanest. Your rate can go up (or down) each year, but interest-rate caps will limit that change to a predictable amount, and your rising income should be able to handle it.”
- Loan: No- or low-documentation loan.
- What: Low-documentation loan is “a mortgage that requires less verification of income or assets (or both) than a conventional loan. Low-documentation loans are designed for the entrepreneur or self-employed, for recent immigrants with money in foreign countries or for borrowers who cannot or choose not to reveal information about their incomes.”
- Why: “Though you’ll pay a higher interest rate, not having to produce paycheck stubs or employer references, which you would be expected to supply when applying for a traditional loan, can be a huge help to those with variable incomes.”
Planning to live in home 4 or 5 years
- Loan: A 5/25 hybrid loan.
- What: Hybrid loan has some of the features of both fixed- and adjustable-rate mortgages. A 5/25 hybrid loan offers “a fixed rate for the first five years and then converts to a one-year ARM for the remaining 25 years”.
- Why: “If you won’t keep the loan longer than five years, why pay extra to lock in an interest rate for a longer period? If you do end up staying longer, you can either refinance or live with an interest rate that adjusts every year.”
Job relocation for a short run
- Loan: Interest-only mortgage.
- What: Interest-only mortgage is “an advance of money in which the installments pay only the interest that accumulates on the loan balance. The loan balance does not decrease with the payments. Usually the interest-only payments last for a limited period, after which payments rise and the borrower begins paying principal in addition to interest.”
- Why: “These loans can be a smart tool for financially sophisticated borrowers who already have assets built up. Monthly payments are low because you’re not repaying principal, so you can afford a larger loan.”
Active duty military or veteran
- Loan: VA loan.
- What: VA loan is a mortgage “made by an approved lender and guaranteed by the Department of Veterans Affairs, often with a low down payment.”
- Why: “The Department of Veterans Affairs offers loan guarantees that allow qualified military personnel and veterans to take out mortgages for as much as $417,000 with zero down payment.”
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