If you’re thinking about buying a home sometime soon, you already know there’s a lot to consider. Besides shopping for floor plans and neighborhoods that suit your needs—and an asking price that fits your budget—you’ll also have to find the right mortgage.
Securing a home loan is about more than getting approved and signing on the dotted line. It’s a journey that can be jammed with confusing jargon and seemingly endless options when it comes to types and terms. And here’s the really stressful part— decisions around your mortgage term could have consequences for your financial future.
A little knowledge about how the different options work could help narrow the choices and could make choosing a loan term a bit easier. Here are some basics you’ll likely run into during your search:
Fixed-Rate or Adjustable-Rate Mortgage?
One of the first steps most loan seekers must take when loan shopping is deciding between a fixed-rate or adjustable-rate mortgage (ARM). (There are other types of loans out there, but these two are the most common choices.)
Each has its pros and cons, and it can be an intimidating choice, but the terminology is spot on. With a fixed-rate mortgage, the interest rate is set when the borrower takes out the loan and remains constant for the life of the loan.
With an adjustable-rate mortgage, after an introductory period that may last months or years, the interest rate could rise or fall, depending on the financial index to which the rate is tied.
ARMs typically start out with a lower interest rate and payment than fixed-rate loans, which makes them attractive to some homebuyers. It’s the unpredictability of future rate fluctuations that can be a downside.
Though many ARMs have caps on how high or low the interest rate can go, over time, borrowers could end up with payments that are larger than they want or can afford.
So it’s important to be clear about a loan’s annual and lifetime rate caps, as well as the loan margin and index the loan is tied to in order to get an idea of how much and how often the rate can adjust. A 7/1 ARM, for example, would have a fixed interest rate for the first seven years of the loan, then the rate could change annually.
Fixed-rate mortgages take the anxiety out of possible rate fluctuations, which makes them a popular choice for borrowers who plan to live in their new home for longer than average, which is currently slightly more than 13 years.
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Fixed rate type of loan would have to be refinanced in order to take advantage of any substantial drop in interest rates during the life of the loan. A homeowner would need to decide whether refinancing would make financial sense for their particular situation, based on the available interest rates, fees involved, and the number of years they intend to remain in the home. So, which loan is better? As with most things related to home loans, there is no one-size-fits-all answer.
For borrowers who aren’t necessarily looking to stay in their home for a longer period of time or are hoping for lower payments during their first years in a loan, an ARM might be a viable option.
But, the Consumer Financial Protection Bureau warns , borrowers should consider whether they’ll still be able to afford the loan if things don’t go as planned—if they decide not to move, can’t sell the house for what they hoped, or don’t get a pay raise, etc.—and the interest rate happens to goes up to the maximum cap allowed under the loan contract.
For borrowers who like the idea of having stable payments for the length of their loan, a fixed rate could be the better choice. No matter what happens with interest rates in the future, the principal and interest payments will remain the same.
They can build those figures into a budget and an overall financial plan.
What’s the Right Mortgage Length?
The next big decision borrowers have to make is how much time they’ll want or need to pay off their mortgage. A 30-year fixed-rate loan is common in the United States, but there are many options.
Spend a little time with a mortgage calculator and you’ll quickly learn how much you’ll save in interest by going with a shorter loan term (say, 15 years). This loans typically comes with a lower interest rate and borrowers pay less interest over the life of the loan. Shorter term loans also allow buyers to build equity more quickly.
So why are 30-year mortgages more popular than 15 years? Because of their longer term, these mortgages come with a lower monthly payment than loans with a shorter term. Borrowers pay more interest over the life of the loan, but have lower payments each month—which can make a difference in whether some people can even afford or qualify to buy a home at all.
Lower monthly payments can provide more financial flexibility. Borrowers with lower payments can always pay more toward the principal if they want to shorten the length of their loan—but the smaller payments they sign up for can offer a little breathing room when times are tight.
Those who are paying as much as they can afford every month to shorten their loan term may run into trouble if an unexpected expense pops up.
Because there are so many options, it can be helpful to look at your house payments within the context of a larger financial plan and future goals. Will the higher payments that come with a 15-year loan cause you to put less money into retirement savings or toward other debts?
Or are you looking at the home as an investment—a way to build wealth for retirement or to eliminate a costly monthly expense for those years when you’re no longer earning a paycheck?
There’s no right or wrong answer for this financial decision—but there are ways to get help finding the mortgage term that best suits your needs.
You can use an online mortgage calculator to run some numbers yourself, or you might choose to ask a lender about how mortgage amortization will affect the principal and interest at various points in a loan, depending on the term.
(In the first years of a 30-year fixed-rate mortgage, for example, the bulk of your principal and interest payment will go toward paying interest.
Toward the end of the loan term, the ratio shifts to the bulk of the payment going to the principal amount.toward principal.) It can be useful to know what the actual payments will look like to determine what your budget can handle.
Finding the Right Mortgage Term
Many lenders provide mortgage information and help on their websites through informative guides and handy calculators, including SoFi. SoFi has a home loan help center that also covers mortgage refinancing, which some loan holders may find beneficial.
While this won’t be an option for all borrowers, refinancing your mortgage could allow you to adjust the loan term or even potentially qualify for a lower interest rate.
Borrowers who are already SoFi members may be eligible to get a 50% discount on their first home loan processing fee, which could amount to a savings of $500. The application process can be started easily online. You can find available loan options in just a few minutes.
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