Finding the right mortgage sounds like a simple endeavor. But it’s anything but simple. Mortgages are constantly changing and the easy way out is to call up a friend or family member who is a mortgage broker and have them get one for you. Hold on. Before you do that, consider that mortgage brokers are paid a commission or a fee for getting you a mortgage so many have an incentive to push mortgage rates and options that carry higher costs for you.
So what’s a person to do? While there are many credible websites that show different lenders and what their rates are (such as bankrate.com), the first thing you’ll want to do is fully understand the terms of your mortgage.
The Type of Mortgage: Fixed or Adjustable Rate
The very first decision a person makes is whether they want a fixed-rate or an adjustable-rate mortgage (ARM). Of course, we all want a fixed-rated mortgage. No one likes the idea that your mortgage can go up and up. But in actuality, fixed-rate mortgages are quickly becoming a dinosaur thanks to changes in bank offers.
Banks tend to lose money on fixed-rate mortgages and so the interest rates and fees these types of loans are often much higher.
The other option is an adjustable-rate mortgage. Let’s take a look at my favorite, the 5/1 ARM that is fully amortized over 30 years. When looking at an ARM, you’ll see the interest rate listed, for instance 3%. That is the rate that is locked in for 5 years and then will change each subsequent year.
What Happens in Five Years?
With a 5/1 ARM, your mortgage rate will adjust after five years and will continue to do so each year following. The new rate will be determined by the index that the mortgage is tied to along with a given margin. The two numbers determine the amount that you pay each month. (Learn more about adjustable-rate mortgage indexes here). The index that your mortgage is tied to is one of the most important factors as some indexes are more volatile than others.
Here are some common mortgage indexes in the United States:
- 11th District of Cost of Funds Index (COFI)
- 12-month Treasury Average Index (MTA)
- Constant Maturity Treasury (CMT)
So how do you know which index your adjustable-rate mortgage is tied to? You can easily look this up on the web along with the margin – which are usually anywhere between 2% to 3%.
Mortgage Caps: What if Mortgage Rates Go Up?
Unlike the old adjustable-rate mortgages, you have an annual and a lifetime cap on how high the rates can go. For example, typically your mortgage cannot go up more than 2% a year (even if the rates go higher). This is called the annual cap.
Also the typical lifetime cap is a 5% increase. This means that if you started with 3% ARM, your rate wouldn’t exceed 8% over the 30-year term of the mortgage. So you are somewhat protected from drastic swings in the market but keep in mind that even a few percentage points can cause significant shifts in payment amounts.
Mortgages and Fees: What to Know
Most people don’t know that a lot of mortgage fees are negotiable. There are even services that will do your title insurance for a lot less than the mortgage provider would charge you. When shopping for a mortgage, it’s best to do as much research as you can on all the different fees. That’s where APR (Annual Percentage Rate) becomes important. You may find two loans offered at the same rate and the same terms but one has a higher APR. This means that you are paying more fees to obtain that loan.
15-Year vs. 30-Year Mortgages
Obviously, a 15-year mortgage will have a higher monthly payment. If your goal is to pay off the house as soon as possible (and I don’t recommend this while you are still working), then go for it. But if you intent to stay in the home for longer than 10 years, go for the 30 year mortgage.
Don’t Chase Interest Rates
We have been in a low interest rate environment for a long time now and unfortunately, I have seen many people re-finance their loan every year to take advantage of a lower interest rate. It always sounds like a good deal but they never factor in all the fees that they paid for each “no cost” re-finance. I just counseled a young woman who refinanced once every year for the last 3 years. Yes, her payment was lower but she never realized that her overall mortgage balance grew.
Taking out a mortgage to buy a home or refinance is a big decision. Take the time to research rates, terms, and caps. It will pay off for you in the long term.
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