Your Guide to Credit and Personal Finance

Choosing the right home loan
This basic guide to the pros and cons of different kinds of home loans can help you pick the mortgage that’s right for you.

You have a lot of mortgage options to sift through when you’re buying a home, and making a decision can feel overwhelming. Here is some information to help you understand different kinds of home loans and find the best mortgage for you.

Fixed-rate mortgages
As the name suggests, the interest rate on a fixed-rate mortgage stays the same throughout the term of the loan. Fixed-rate mortgages appeal to people who:

• Will likely stay in their home for more than three or four years.
• Want to know that their payments will stay the same over the life of the loan.

Most fixed-rate mortgages are for terms of 30 or 15 years; the interest rate on the shorter-term loan is less, reducing the overall cost of the loan for people who can afford the higher monthly payments.

Adjustable-rate mortgages
Monthly payments on an adjustable-rate mortgage can adjust up or down depending on market conditions, usually every one, three or five years. ARMs may appeal to:

• People who know they will be in their homes for less than three years.
• Buyers who want significant savings on interest early in the loan. They may plan to refinance or sell before the rate adjusts and are willing to take the risk that they will be able to do so.
• Buyers who believe interest rates will go down.

Hybrid mortgages
Hybrid mortgages are a blend of the features of fixed and adjustable rate mortgages. A Hybrid ARM has an interest rate that does not change for several years (the fixed term), after which it adjusts every year for the life of the loan. The most common hybrid mortgages are 3/1 and 5/1 mortgages which have a fixed rate of three years and five years, respectively, and then adjust annually after the fixed term expires.

Hybrid mortgages may work if:

• You plan to sell or refinance before the fixed term ends.
• You want to save on interest during the early years of the loan and will be able to afford potentially higher payments when the rate adjusts.

Option ARMs
These adjustable-rate mortgages allow you to select from up to four payment options each month. The minimum payment is low at first, but can rise quite a bit after an introductory period. You’ll build equity more quickly if you choose higher payments. If you choose the minimum payment too often, you won’t be building equity in your home and could even increase your loan’s balance.

Option ARMs may work for you if:

• You want flexibility because your income fluctuates. (For example, if you work on commission and may be able to make very large payments one month, but much smaller payments the next.)
• You are financially disciplined and won’t be tempted to pay only the minimum each month. Paying just the minimum can lead to a dangerous scenario where you owe more than the loan’s original amount.

Interest-only and balloon mortgages
Interest-only and balloon mortgages allow you to make lower payments for a number of years. But you won’t build equity on an interest-only loan, and eventually your payments will increase after the interest-only period expires (usually five to ten years). A balloon mortgage offers low regular payments for a number of years, but then requires you to pay off the principal all at once.

Interest-only or balloon mortgages may work if:

• You expect a financial windfall down the road that will allow you to pay off or pay down your mortgage.
• You have a temporary financial crunch.
• You plan to sell quickly.

Keep in mind that many mortgage lenders have cut back dramatically on more exotic loans, and some won’t offer them at all. Carefully consider your long-term financial situation and tolerance for risk as you mull your choices.

How to compare loans
Asking these questions when comparing loans can help you save money and find the loan that best suits your needs.

Comparing mortgage loans is one of the most important things you can do when you’re buying a home. The decisions you make will determine the size of your monthly payments, how much you pay upfront, and how much interest you’ll pay over the life of the loan.

You might find it simpler to compare loans if you ask each lender a series of questions, including:

• What is the loan’s interest rate?
• Will I be charged points?
• What are the closing costs and all other fees?
• What is the annual percentage rate, or APR - the rate you’ll pay per year for all the costs associated with the loan?
• Is there a pre-payment penalty?
• How is the loan amortized, meaning how quickly is the principal paid off?

Find out the answers to these questions no matter what type of loan you’re considering. Each can affect the overall cost of your loan.

If you are considering an adjustable-rate mortgage, or ARM, you can compare loans by asking:

• When does the rate adjust?
• How often does the rate adjust?
• Is there a cap limiting the amount by which the rate can adjust? What would my monthly payments be if my interest rate hit that cap?
• What is the index and margin that will determine my rate? How has the index changed over time?

ARMs are inherently more risky than fixed-rate mortgages because you’re gambling on whether interest rates will go up or go down before your rate adjusts. Understanding the best- and worst-case scenarios can help you weigh the pros and cons as you compare loans.

But there’s one other big question to consider before you get an ARM:

• How does the discount introductory rate compare with rates for 30-year fixed-rate loans?

If there’s not much difference when you compare the two, the fixed-rate loan might be a safer bet. You won’t save much in the short-term, and could save a lot over the long term. Plus, you reduce your risk if interest rates shoot up and you can’t refinance before the rate adjustment.

Finally, to truly compare loans, you have to ask yourself some questions:

• How long do I expect to stay in my home?
• Are my job and income secure over the long term?
• Will I be able to afford higher payments in the future?
• How comfortable am I with risk?

In the end, the best loan is the one that works for your needs.

4 steps to evaluating your current loan
Thinking of refinancing? Here’s how to evaluate your loan before you make a move.

The prospect of a lower interest rate may have you thinking about refinancing. Or you may be looking to refinance to replace an adjustable-rate mortgage. Whatever your reason, refinancing your loan has the potential to save you money. But how do you know whether you can really save by refinancing your current loan, and whether the savings are worth the cost?

Here’s a step-by-step guide to evaluating your current loan:

Step 1: Pull out your loan documents and look at the terms.
What interest rate are you paying? Is the rate fixed or adjustable? If you have an ARM, when is your rate due to reset? To figure out how much your rate (and monthly payments) could increase, look for your loan’s index and margin as noted on your loan documents. Read more about how ARM interest rates are calculated in our article ARM indexes. And finally, is there a prepayment penalty that could cost you big money if you refinance?

Step 2: Compare your loan’s interest rate with current interest rates.
If you took out a fixed-rate mortgage several years ago and interest rates have since dropped, refinancing may lower your payments considerably. A $150,000 mortgage with a 30-year term and a rate of 8 percent, for example, carries a monthly payment of $1,100. The same mortgage at 6 percent will have a payment of less than $900 a month. Remember, the interest rate you qualify for is based on several factors, including your credit score and your loan-to-value ratio. So don’t automatically assume that you’ll qualify for the lowest rate out there.

Step 3: Think about how long you expect to stay in your home.
Before you make a move to refinance, it’s a good idea to think realistically about your long-term plans. If you expect to move in a year or two, you may not realize the savings you could potentially get from refinancing. In general, the longer you plan to stay in your home, the more sense it may make to refinance.

Step 4: Figure out your break-even point on the refinance.
If your closing costs will be $3,500 and you’ll save $100 a month on payments, it will take you almost three years to recoup those costs. If you plan to move in a year or two, refinancing may cost you more than it saves you. If you plan to stay longer, though, the savings through lower monthly payments can really add up. For more information on calculating your break-even point read the article When does mortgage refinancing pay  or use the LendingTree.com Mortgage Refinancing calculator.

Other factors can come into play when you evaluate your current loan and compare it with refinancing options. For example, you can save on interest over the life of the loan by refinancing into a 15-year fixed loan rather than a 30-year loan. Your monthly payments will be higher than on a 30-year term, but you’ll pay less interest over all by choosing a shorter term.

You can easily evaluate your current loan and compare it with possible refinancing options using the no-obligation LendingTree Mortgage Checkup.