It is that time of year again. That time of year when people are putting their homes on the market and others are looking to buy a bigger home, a smaller home, or their first home. If you are looking for a house there are number of key things you have to think about. One of them is what kind of mortgage do you want to take have. Before I give you my opinion let’s take a look at a few mortgage types.
*Note: I am not a mortgage expert (but my sister is) and I obtained a lot of great information from our home search last year and if I ever need advice I just talk to her or my brother-in-law.
1) Fixed-rate mortgages. Fixed-rate mortgages are a mortgage for a specific time period (typically 30 years, 20, 15, or 10 years) where your mortgage percentage rate is fixed for the life of the loan.
2) Adjustable Rate Mortgage. Typically, ARM loans have a lower fixed rate for a specific amount of time (e.g. a 5/1 ARM or 7/1 ARM). The first number indicates how long the fixed-rate is. However, after that time the loan will adjust to, typically, a larger interest rate depending on the larger market. So it is only fixed for a short-period of time not the entire history of the loan.
3) FHA Loan. An FHA loan is a loan offered by the Federal Housing Authority. These types of loans are often fixed rate. The primary advantage of these loans is that your down payment is much lower (typically 3.5% of the purchase price of the home). However, you are often limited to how much you can borrow (I think it is $417,000) and you will also have to pay PMI (private mortgage insurance) for the life of the loan. That PMI will add about $150-200 onto your payment every month. However, they can be great for people who don’t have larger down payments.
4) VA Loans. These loans are available for former and current service members where there is little to no down payment needed. However, the size of the loan is limited and one can get in trouble with by providing now down payment on a house.
5) Interest-Only Loans. These are the kinds of loans that got us in trouble with the 2008 financial crisis. In essence, you are only paying the interest on your loan for a specific amount of time. However, after that time period is over the balance of the loan is due. If you don’t make additional payments on top of the interest you will be stuck with a huge balance to keep your house.
There are other loan products other there, but they are not very common and don’t really come in handy when buying a house.
So Which Loan Is Best?
In some respects this depends on your situation. If you are planning on being in the house less than five years than choosing a smaller ARM loan might be a choice to make. However, if you are going to be in a house less than five years I might suggest that you don’t buy a home to begin with. Financially it isn’t worth it because you might not have paid down enough principle to get the money back that you used to buy the home in the first place. By the time you sell the house, pay realtor fees, and other fees, you might actually lose money. And if the home goes down in value well then it was a bad financial move.
An FHA loan can be a valuable tool for people who are wanting to get into a home for a first time, but don’t have a large down payment. And you can get a fixed-rate FHA loan you will know what your housing costs are for the life of the loan. The problem with the FHA loan is, in my opinion, the lower down payment you get to buy the house and the fact that you will have to pay PMI for the life of the loan, unless you eventually refinance your FHA loan. I think the more money you can put down on a home the better. You create instant equity for the house, provide a much lower loan balance, and you might actually be able to buy a bigger house. Additionally, PMI can cost you thousands of dollars in fees that isn’t really for you, but to protect the bank.
Personally, I think VA loans and the interest only loans are bad products. Too many fees, not enough paying down of interest, and the terms of the loan can be horrible.
Conventional fixed-rate mortgages have the advantage of being a fixed-rate for the life of the loan. You basically know how much your housing costs will be each month until you pay off the mortgage. Most likely, your income will go up over the course of the loan, which means eventually your discretionary income will go up and you continue to gain equity into your home. However, if interest rates go down then you might be stuck with a higher interest rate. Also, conventional fixed-rate mortgage requires a larger down payment (sometimes 20% to get the best interest rate). Unfortunately, a lot of people don’t have that 20% down payment and it makes it harder to own a home.
In my opinion, you can’t beat a conventional fixed-rate mortgage. And I would advocate for the shorter the loan period the better. For example, Mrs. ROB and I have a 15 year fixed rate loan. We could’ve borrowed more money, gotten a bigger house, or lowered the payments with a much longer loan.
However, a couple of things factored into our decision to get a 15 year fixed rate loan. 1) Pay off the house faster. 2) Less debt in the longer-term. 3) Building more equity into the home if we decide to sell it someday. Those are the three primary reasons to choose a 15-year fixed rate loan.
The Bottom Line
I think owning a home is a great option for most people. However, I also understand that in some parts of the country that it can be unaffordable for some because of lifestyle, debt, place in life, or the expensive nature of the area (e.g. San Francisco).
The Mortgage Loan Winner: A 15-Year Fixed Rate Mortgage. If you can swing it and are in the market for a home. I think it is the clear winner. In future posts, I will talk about some of the things that I learned when we were buying our house.