Choosing the right kind of mortgage is a lot like choosing a spouse. (That might sound like crazy talk, but hang in there with me for a minute.)
Like the millions of single men and women milling around out in the world, there are dozens of mortgage options from which you can choose. So, how do you know which mortgage is the right one for you?
Not like dating, picking a mortgage should not be by trial and error. When you date, you can go out with different people and quickly learn what you are looking for and not looking for in a spouse.
Uncovering which mortgage is the one you want to marry with the purchase of your home (or even a refinance of your home) should be a well-thought-out process that leads you to the best option for your personal financial situation.
1. Set Your Goals
“When you fail to plan, you plan to fail.” True story. Buying a home is a HUGE financial investment.
In fact, it is likely one of the biggest ones you’ll make in your lifetime. So, you have to set goals for it. One of the first goals you want to set is your intention with the home.
- Do you plan to live in the home for the rest of your life?
- Are you planning to raise your kids here and then sell and move into a smaller home?
- Is this a starter home for the next five years and then you’ll upgrade to a larger, more spacious home?
Once you move out (if you move out) will you sell or keep the home and rent it out?
You might be wondering what all of this has to do with choosing the right mortgage. The answer is it has everything to do with the type of mortgage that you choose. The length of your stay in the home affects all of the decisions you make in choosing a mortgage, from the term to the type, and more.
2. Pick a Term
The term of the mortgage is the total number of years the mortgage is going to be in place. A 30-year mortgage has a term of 30 years, for example. In fact, a 30-year fixed rate mortgage is probably one of the most popular mortgages because it tends to offer the lowest monthly payment (because the payments are spread out over a 30 year period, as opposed to 15 years, for example).
But, is this term right for everyone?
Not necessarily. It all goes back to your goals with the home and your goals with the mortgage. If you’re going to live in the home and have the mortgage for the next five (5) years, does it matter that the interest rate is fixed for 30 years?
No, it doesn’t.
If you’re going to live in the home for the rest of your life and you intend to pay off the mortgage in the next 15 years, then you do pay less interest (and less money in the long run) if you choose a mortgage with a shorter term, such as a 15-year mortgage. The same holds true if you only intend to live in the property for five years. The catch is that you have to be able to afford to make the monthly payments, which can be slightly higher because the term of the mortgage is shorter.
So, if you’re looking at a 30-year fixed rate mortgage with an interest rate of 4% for a 300,000 mortgage, your monthly payment is going to be $1,432 per month for the entire 30 years that you have the mortgage.
On the other hand, the same $300,000 mortgage with a 15-year fixed rate mortgage with an interest rate of 3.25% is going to have a monthly payment of $2,108 per month for the entire 15 years you have the mortgage.
With the shorter term (15 years), your monthly mortgage payment is much higher than the longer term (30 years) even though the interest rate is lower because you have to pay off the mortgage in half the time.
3 Decide What Your Budget Is
Affording the monthly payments for the mortgage (and all of the other costs of owning a home) is also a big factor in which mortgage you choose.
Find the balance between the monthly payments you can afford and finding the mortgage that offers the terms and conditions that help you to meet your goals and stay within your budget.
4 Find out the Interest Rate (BUT Don’t Focus on It)
It’s NOT all about the rate. People get very hung up on the interest rate when they are shopping for and choosing a mortgage. Trust me, there is a lot more to choosing the right mortgage than which one is offering the lowest interest rate.
Don’t get me wrong.
The interest rate is important because it determines your monthly principal and interest payments, but it’s not where your decision ends.
The lowest interest rate is not always the best deal. Primarily, what you want to compare is the annual percentage rate (APR). The APR takes your monthly payments (and interest rate) into consideration, but it also incorporates all of your upfront costs, such as closing costs.
So, when you are comparing one 15-year fixed rate mortgage from one lender to a 15-year fixed rate mortgage from another lender (it has to be the same type of mortgage), look beyond the rate to the APR. The lender with the lowest APR is the one offering the least expensive deal overall.
5 Shop and Compare Lenders
When you decide you’re going to buy a new flat-screen TV, you do not just run out to the closest store and slap your credit card down on the counter. At least, most people do not behave this way.
Since buying a flat-screen TV is not as expensive as buying a home, it’s even more important to approach establishing a mortgage in a cautious way.
What I’m trying to say is that you want to shop around, talk to, and compare at least three mortgage lenders or companies (Some example mortgage lenders are Wells Fargo, Lending Tree, and Quicken Loans.) before making a final decision. You’re probably going to find that you find a least expensive option, a middle-of-the-road option, and an expensive option.
This is normal when you are comparison shopping for, well, anything! What you really want to make an effort to do is make sure that you are comparing apples to apples and oranges to oranges.
6 Find the Balance
In the end, choosing the right mortgage for you comes down to finding the balance between all of this items: (1) your goals with the home and the mortgage, (2) your personal financial situation, (3) the mortgage interest rate, (4) the mortgage term, and (5) the APR.
I thought the mortgage interest rate is your Annual interest rate. How is it different?
Excellent article!
Very important info, as am currently searching for a house. I really appreciate!
I have a ch13 that I paid off early so I could get out of that hell. I am living in my rental property and want to purchase another house. My credit score is 688 now and going up. The ch13 was a huge mistake that I never should have filed! Now I am trying to find a lender for a new mortgage with zero results. Do you have any advice for me or ways in which I can find a lender? ……. To all of your readers and fans….whatever you do, try your hardest to avoid bankruptcy! It has ruined me ability to get a good interest rate on everything, if I get approved at all.
Terms on Commercial mortgage One Million Two Hundred thousand dollars. I am interested in seeing the math on a thirty year fixed mortgage are interest rates for commercial property around 2 1/2 percent somewhere under three percent. I also would like to see the math on 15 year fixed mortgage Commercial rates on $ 1,200,000 dollars.
I need extra help i know the home i would like tobe in. The probelm come in is my credit score. Iswithin hundred points for me to qualify for a loan. The type of home i am intrested in is a hud home foreclosure. I honestly need to speak with someone and not all this email so i can finally understand the steps i need to make on a home.
Ronetta,
Perhaps this article on dealing with credit history while buying a house will help you?
Thanks for reading!
Great information here!!!
Very nice refresher of what we have read or forgotten. I think your readers would benefit also from advice about taking the 30-year mortgage and making additional payments toward the principal as alluded to in the article.
Option 1: 30 yr Mortgage, 4.2% int rate = $978 pmt, $152,092 interest paid in 30yrs
Option 2: 15 yr Mortgage, 3.2% int rate = $1400 pmt, $52,086 interest paid in 15yrs
A 3rd option to your example above:
If you prefer to be liable for a smaller monthly payment but have the income to pay more, choose a 30 year mortgage and send in an extra monthly principal payment using the $425 monthly savings between 15 and 30 year loan.
Option 3: 30 yr Mortgage, 4.2% int rate = $978 pmt + $425 extra monthly principal = $77478 interest paid in 17.2 years. That’s almost $78000 in interest savings.
(you can knock this down to 16 years if you shop around for a 3.9% rate for example)
The advantages to Option 3 is you’ll be paying down your loan almost as quickly as a 15 year mortgage but have the safety net of a lower monthly liability in case you need some financial breathing room to deal with life’s emergencies.
This option also gives you greater foreclosure protection; Can’t make the $1400 payment this month? Pay the $978 with no default and tag on an extra month to your payoff. Can’t make your $1400 on your 15 year; DEFAULT
This is exactly what I was thinking Joe!! Thanks for posting this example.