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.