By Sara Bristoll
It’s time for you to get a mortgage for that home you’ve been wanting in Phoenix. You walk into a branch, sit down to talk with someone, and they ask, “What type of mortgage are you looking for?” At that point, your mind goes blank and all you can think is, “Uh… a regular one?”
What most people don’t know is that there are many different types of loans you can obtain on your house, depending on what you’re looking for and can afford. Here’s what you need to know to help you make a decision about which mortgage product might be right for you.
• Conventional Mortgages typically require a 20 percent down payment – that means you, the buyer, will have to pay for 20 percent of the purchase price out of pocket, in addition to any closing costs. The most common term (length of loan) for a conventional mortgage is 30 years, followed by 15 years and 20 years.
Now, if you have the option to stretch out the payments for longer, why wouldn’t you take the lower monthly payment? For starters, a 15-year mortgage typically has a lower interest rate than a 30-year mortgage. Even if the rates were the same, the shorter mortgage term means you’re paying quite a bit less in interest over time. For example, a $200,000 mortgage at a fixed interest rate of 4.5 percent would pay $164,813.42 in interest over 30-years. If that loan were only 15-years, the interest cost would be $75,397.58 – which is close to $90,000 less in interest over the life of the loan.
• Adjustable Rate Mortgages (ARM) can look very attractive because of their low introductory payments and interest rates. These loans typically have a fixed rate for a period of time. Once that timeframe passes, the rate will adjust based on the market.
With a 5/1 ARM, you lock in your payment at 3.65 percent (for example). After five years, your payment adjusts to the new market rate. If the economy is booming and the rates increase 2 percent in those five years, your monthly mortgage payment could go up $250 on a $200,000 loan. And the rate changes don’t stop there. With a 5/1 ARM, your interest rate can go up once every year for the remainder of the loan. Essentially, you’re betting (or hoping) rates are going to decrease during your fixed-rate period.
• Low-down payment mortgages include first-time home buyer programs, FHA loans and conventional mortgages where you don’t put 20 percent down. These loans are designed to make it easier to get into a house (because saving for a down payment is increasingly difficult with all of our student loan debt). The caveat is that you have less equity in your home making it easier to be underwater (owe more than your home is worth) if home values drop.
These loans almost always require mortgage insurance (PMI) added to the loan, which includes an up-front premium when you close on the loan and annual payments. The current up-front premium for an FHA loan is 1.75 percent of the loan amount, or $3,500 on a $200,000 loan, and if you put down less than 5 percent on the same loan, you’ll be paying 0.85 percent of the loan balance every year ($1,700 on the first year).
You can only avoid mortgage insurance premiums by having a down payment that is at least 20 percent on the loan. If you don’t have this saved up, look into first-time buyer grants funded by the county, state and city you live in. Many of these don’t have to be paid back.
Now that you know a little bit more about your loan options, remember to get pre-approved for your mortgage before you start shopping!