18 Jan Know Your Mortgage: 30-Year, 15-Year, Fixed, and ARM
At the end of 2020, mortgage rates hit record lows. These rates, combined with spending more time at home, are motivating people to search for a new home. Locating the perfect property is just one part (and maybe the fun part!) of the home buying process. The first step is to understand how you are going to finance your purchase. In another post we explored some different loan and down payment options. Today let’s take a look at some pros and cons of the different mortgage types.
Fixed-Rate Mortgage
A fixed rate mortgage is one in which the interest rate stays the same throughout the life of the loan. This type of loan is an amortizing one. This means the borrower makes regular monthly payments. A portion of each payment goes towards the interest rate while the remaining goes towards the principal. The principal is the amount owed on a loan, without interest. As the amount of interest owed decreases, the portion of the payment toward the principal increases. Borrowers who want consistent monthly payments and plan to live in their homes for at least 7-10 years generally choose fixed-rate mortgages.
Fixed-rate mortgages usually have a 30 or 15-year term. There are benefits to each of these terms.
30-Year Mortgage Benefits
This longer mortgage term means lower monthly payments. A 30-year mortgage will help you maintain a lower debt-to-income ratio. This will benefit you should you want to take out any additional loans. It will also keep margin in your monthly budget. This margin protects you in the event of unexpected expenses or loss of income.
15-Year Mortgage Benefits
A borrower will pay less in overall interest with a 15-year loan than with a 30-year loan. The larger monthly payments, coupled with lower interest rates, also means you build equity faster. A 15-year mortgage is a good option only for those with a reliable income who are confident they can afford the larger monthly payments.
It’s possible to reap the benefits of both of these loan terms with prepayment. Prepaying usually means making additional monthly payments to the principal only. You will have the benefit of being locked in with affordable monthly payments but can pay the loan off quicker as you are able. It’s important to know if your mortgage has a prepayment penalty. Lenders want to collect as much interest as possible, so some will penalize you if you pay the loan back early, refinance, or even sell your home. It is illegal for some loans, such as VA or FHA, to carry a prepayment penalty.
Adjustable-Rate Mortgage (ARM)
An Adjustable-Rate Mortgage earned its name because of its variable interest rates. There is an initial rate period in which the interest rate is set below the market rate. This initial period is preset and generally ranges from 1-10 years. Borrowers can save hundreds of dollars each month during this initial period. At the end of the period the interest rates shift to the current market rate. This could be an increase or for lucky borrowers, their rate would drop even further.
When choosing an ARM, borrowers run the risk of not being able to afford their mortgage payments if the interest rate increases dramatically. When considering this type of loan, you need to define what is the maximum monthly payment you can afford.
Adjustable-Rate Mortgages are beneficial for those who know they will only be living in the home for a few years or will pay off the home very quickly. It is also an option when buying during a time of high interest rates and a rate drop is anticipated. With today’s low market rates, it’s unlikely that borrowers will see a rate decrease.
These details are just some of the things you need to be aware of when financing a new home. This is a general summary, and you should always seek the advice of a trusted lender or financial advisor.
Here are some lenders I recommend:
- Tom Corcoran, United American Mortgage, (206) 965-8424
- Jeff Nicola, Bay Equity Home Loans, (206) 779-1874
- Kyle Hendricks, Caliber Home Loans, (253) 355-0247
The homebuying process can be overwhelming. It is also very exciting and can be a positive experience with the right team on board. I look forward to supporting you on the path to homeownership!
Photo by Rattanakun Thongbun, Canva