Choosing the Right Mortgage

You've decided to look for your first home or you're looking for a new home.  Before you start looking seriously, you should become informed about the choices in mortgages and set things in motion.  Many sellers will not show their properties to buyers that are not "pre-qualified" for the loan.  They consider it a waste of time.

Special Note:  Before you start shopping for mortgages, see our Reference Library article entitled, "Protect your Credit", and get your own credit scores.  Multiple enquiries from lenders will reduce your credit score.

Also, see our article in the Reference Library entitled, "Mortgage Preparation Checklist" to get all the documents and information ready for the loan application process.

There are many choices out there, but mortgages generally fall into two major categories:

Fixed Rate Mortgages (FRM):  The advantage of the fixed rate mortgage is that the interest rate and the monthly payment will never change throughout the life of the loan.  There are a few things to consider in a Fixed Rate Mortgage:  

• Consider the term.  Mortgages are available for 10, 20, or 30-year terms.  The shorter the term, the higher the payment.  The longer the term, the lower the monthly payment.  But, the shorter the term, the less interest you will pay over the life of the loan, making the total outlay of money less.   The best option depends on your situation.
• Make sure you mortgage has NO prepayment penalty.  This allows you to make extra payments in the future and to repay your loan prior to the established term.  In 30 years, you will likely get promotions and make more money.  The savings on paying down your mortgage yields you a high saving in interest which is usually a higher yield than any investment.  You are also building equity in your home.
• Get a mortgage that allows for weekly or bi-monthly payments.  For example, if your monthly payment is $1000, you could pay $250 per week, or $500 twice a month.  This can take years off your term.  Why?  Because every payment reduces the interest due over the life of the loan.  You don't pay anything extra, just reduce interest more often.
• If you can qualify for a Fixed Rate Mortgage, this is likely the best choice if you plan to stay in the home for a long time. 

Adjustable Rate Mortgages (ARM):  This type of mortgage is attractive because it has a lower interest rate at the beginning of the loan, often lower than a Fixed Rate Mortgage.  It is often easier to qualify for an Adjustable Rate Mortgage because the initial payments are lower and less income is required.  Or, you can qualify for a higher amount loan based on the lower initial interest rate.  Things to consider in an Adjustable Rate Mortgage:

• Make sure you find out how long the initial rate is valid, the maximum percentage of increase in interest at the first adjustment, and the maximum increase in interest over the term of the loan.  As an example, the initial rate is valid for three years, then a maxium increase would be 2%, with a maxium interest rate increase of 6% over the life of the loan. 
• Remember that interest rates right now are near historical lows.  There is likely only one way that interest rates will go -- and that's higher. 
• Make sure you are allowed to convert your ARM into a FMR at certain points during the loan.
• Make sure there NO prepayment penalties.  The lender of an ARM often counts on that increased interest rate in the future, and may charge a penalty if you pay off the loan, or sell the home in the short term.
• An Adjustable Rate Mortgage can be an excellent choice if you plan to live in your home for no more than 3-5 years.  This allows you to take advantage of the lower interest rates without worrying about the potential future increases.

When you get your loan, make sure you get an "Amortization Schedule".  This shows you the amount of principal, vs. the amount of interest, for each payment over the life of the loan.  For the first half of the term, the majority of the payment goes to interest, with very little paying down the principal.  The lender wants to be sure they make their money at the front end.  This is also the best time to make extra principal payments if you can.  As the loan balance reduces, the amount of your payment toward principal increases, and the amount that goes to interest decreases.  So, if you get a bonus of $5,000, you can send that as an extra payment toward principal.  Take a look at the amortization schedule, and you will see that this amount could cut five years off your term if paid within the first few years of your mortgage!

Interest Only Mortgages:  This has become a popular offer from lenders.  Why?  It works for them, but it doesn't work for the borrower.  Your payments are lower at the beginning, but you are not reducing the loan balance -- only paying interest.  While there may be cases where this can work to the advantage of investors or in commercial real estate, this is NOT a good choice for anyone buying their own residence.  

Mortgage Brokers:  A mortgage broker is someone who will "shop" for the best mortgage for you.  Unless your have a real credit problem, you should avoid using a mortgage broker because they will charge you for their services, usually as a percentage of the loan.  This is payable at closing and could exceed $1000 in settlement charges.  If possible, go directly to the lender.  They also can assist you with many choices, though highly institutionalized lenders such as national banks, have a lower risk tolerance.

There are many choices.  Shop around and make sure you verify the reliability of the lender with the Better Business Business Bureau if it is a company without national reputation.  And, remember to get your own credit scores before you start shopping!