Once you've decided to take the plunge and switch from renter to
homeowner, your first step should be to research your financing
options so that you can decide which loan term best suits your
needs.
The Mortgage Bankers Association reported that 85 percent of
purchase home loans in June 2012 were
30-year fixed-rate mortgages
, popular among both first-time and repeat homebuyers. But before
you jump on the 30-year bandwagon, you should understand all the
loan-term options available to ensure you're getting the best home
loan to suit both your lifestyle and financial needs.
Fixed-rate home loans
Fixed-rate home loans are available in a variety of terms,
including 30, 20 and 15 years. Some lenders even offer less-popular
7, 10, 17 or 25-year loan terms.
"Thirty-year fixed-rate mortgages are really the driving force
behind homeownership in the U.S. because they offer the lowest
monthly payments along with the security of stable payments," says
Malcolm Hollensteiner, director of retail sales for TD Bank
headquartered in Cherry Hill, N.J., and Portland, Maine.
Gregg Busch, vice president of First Savings Mortgage Corp. in
McLean, Va., says there's really no downside to fixed-rate loans
because they offer
first-time homebuyers
a conservative way of paying for a home without the danger of any
sticker shock from changing mortgage payments.
While the monthly payments on 30-year mortgages are lower, 20 or
15-year mortgages
allows you to pay off the loan faster because of the shorter term
and lower mortgage rates. Hollensteiner says the interest-rate
spread between a 30-year and 15-year mortgage could be as much as
0.75 percent to 1.00 percent, while the spread between a 20-year
and 30-year are usually a little closer.
"Your monthly payments will be about 28 to 30 percent higher on
a 15-year mortgage compared to a 30-year mortgage," says Busch. "If
you can afford the higher payments, a shorter loan allows you to
build equity much faster."
Monthly payments
Let's consider what the monthly payments would be on a $300,000
mortgage at various fixed-rate terms:
- 30-year mortgage at 3.86 percent: $1,408
- 20-year mortgage at 3.65 percent: $1,763
- 15-year mortgage at 3.16 percent: $2,095
Just five years into the loan, the difference in the loan
balance between the 30-year and the 15-year loan is nearly
$60,000.
Hollensteiner says most first-time homebuyers choose 30-year
terms because they tend to focus more on keeping monthly payments
low rather than paying off the loan balance. However, building
equity more quickly benefits homeowners who wish to refinance or
intend to sell in the near future.
Adjustable-rate mortgages
Most
adjustable-rate mortgages
(ARMs) available today are Hybrid ARMs with a fixed-rate period of
five, seven or 10 years. ARMs have an initial fixed interest rate
that is usually much lower than fixed-rate loans. According to the
latest data from HSH.com's weekly Market Trends newsletter, the
interest rate spread between the overall average rate for 30-year
fixed-rate mortgages (conforming, non-conforming and jumbo) and 5/1
Hybrid ARMs is more than a full percentage point.
"If a first-time buyer is not planning to stay in their home
longer than the fixed term or is not maxing out their ability to
handle their mortgage payments, an ARM might be an option," says
Jeff LaMonte, senior vice president for retail sales and business
support with Bank of America in Bakersfield, Calif. "If borrowers
fully understand the loan and can afford to make the highest
possible payments after the loan adjusts, they may be willing to
take the risk in order to save on their initial mortgage
payments."
Monthly payments
Given the lower interest rates, monthly payments on an ARM are
going to be a few hundred dollars less than a 30-year fixed. The
monthly payments on a $300,000 mortgage with a 5/1 Hybrid ARM rate
of 2.80 percent would be $1,233 for the first five years and then
would adjust each year after.
Of course, the downside of any ARM is that your monthly payments
may increase after the fixed-rate period expires. Today, most ARMs
are capped at about 5 percent (the interest rate can only rise by
five percent over the life of the loan). In the example above, the
interest rate could rise to a maximum of 7.80 percent, increasing
the monthly payment by nearly $1,000.
Now that you understand which mortgage terms are available on
the market today, consult with a mortgage lender to discuss your
individual financial circumstances and which product is right for
you.
(Remember, mortgage rates change daily, so the interest rates
used to provide examples in this article may not reflect current
rates. Check back in with HSH.com for today's mortgage
rates.)