Selecting the Right Mortgage

Potential home buyers face a lot of questions. Should they purchase a home? Where is the right location? Which house is the perfect house? How much should they pay? The easiest way to avoid stress down the road is to learn about mortgages.

Start with the basics. A mortgage is a collection of multiple documents outlining specifics of a loan that buyers obtain to allow them to purchase property. Lenders require you to repay your mortgage in monthly installments. The mortgage payment consists of two parts, interest and principal. Interest is what the lenders charge you for borrowing money. The principal is the actual amount that you borrow.

Although there are many different individual mortgages, all mortgages fall into two categories: fixed-rate and adjustable-rate.

Fixed-rate mortgages (FRM) lock in one interest rate that remains the same for the life of the loan. The monthly payment amount also remains the same for the life of the loan. The length of time you have to repay the loan is either 15 or 30 years. Advantages to this option are that the monthly payments remain constant, which allow for easier budgeting, and the interest rate remains constant, thereby avoiding any rate hikes. A major disadvantage would be if interest rates plunged and were lower than your fixed rate. The only way to change your interest rate is to refinance.

Adjustable-rate mortgages (ARM), on the other hand, have changing interest rates and monthly payment amounts. The interest rate is based on an economic index. ARM mortgage rates are generally lower than average interest rates at the beginning of the loan. This is an advantage if a buyer does not plan on owning the property for very long. After the introductory period, the interest rate (and monthly payment) fluctuates based on the index. This becomes a disadvantage if the rates are significantly higher and the buyer can no longer afford unpredictable payments.

A few important questions to consider before choosing an FRM or an ARM mortgage are: how long will the property be owned, how much money will need to be borrowed and are the funds available for repayment of the loan (i.e., will there be enough money to make the payment on a consistent basis).