Buying a House

What mortgage is right for me?

If you’re like most buyers, you’ll choose a 30-year loan, with either a fixed or adjustable interest rate. As the name suggests, the interest rate on a fixed-rate loan stays the same for the entire term. With an adjustable mortgage, the rate remains fixed for a period of time, then resets based on prevailing interest rates. A 5/1 ARM, for example, is fixed for five years and adjusts annually after that.

The ARM’s appeal: The initial rate is lower than the fixed, making monthly payments more affordable. But when the loan resets, the rate could go much higher, landing you in a financial hole if you’re not prepared. (A cap on rates keeps it from being an bottomless pit, but still.) ARMs are best when you don’t plan to stay in the home for the long haul; ideally, you’ll be able to sell and pay off the mortgage before the rate gets too high.

You can lower a fixed rate by shortening the mortgage term to 15 years. The monthly payment will be higher—you’re paying off the debt in less time—but the interest savings are huge. At current average rates, the payment on a $200,000 loan will be about $1,000 a month for a 30-year fixed, $1,400 for a 15-year. But the 15-year will cost you $108,000 less in interest over the life of the loan. Prefer a 20-year or a 10-year? Many lenders offer alternative terms but don’t advertise them.

If you haven’t saved a 20% down payment, you can look at a Federal Housing Administration (FHA) loan, which allows as little as 3.5% down. FHA loans also help buyers with less-than-perfect credit. The catch: You’ll pay a hefty price for mortgage insurance to protect the bank in the event of default. (You can stop paying the premiums once you’ve built up 20% home equity.) Military service members and their surviving spouses are eligible for loans backed by the Veteran’s Administration, which allow for lower and in some cases no down payment with no private mortgage insurance.

People borrowing more than the $417,000 maximum for standard mortgages (the cap is higher for pricey markets like San Francisco) need a jumbo loan. Jumbo rates historically exceed rates for “conforming” loans—though that’s not true these days—and require higher down payments.

Some lenders offer interest-only mortgages, in which borrowers pay interest only for a set term, such as five to 10 years. No money goes toward principal, which means you’re not building any equity in your home. That unpaid principal then gets spread out over the remaining life of the loan, so monthly payments spike after the initial period. These risky loans were associated with some of the worst excesses of the housing crisis, but they serve a purpose for affluent borrowers looking to conserve cash so they can invest it elsewhere.

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