Understanding Your Mortgage Options

Buying a home is one of, if not the, biggest financial decision you will ever make in your life. The entire process can be nerve wrecking even for the toughest of us. Months can be spent looking for that perfect house; endless tours of houses and neighborhoods that become a regular weekend ritual. Then you find the home of your dreams and the real nightmare starts – the mortgage process.

Financing a home is necessary for the majority of buyers because of the large ticket price. Often payments for a home will extend for years, even decades as we pay off this big ticket item. So when it comes time to choose how you will finance your house it pays to take the time to understand all of the options available to you. Remember, this isn’t a car loan that will be gone in a few years – this is where you will live, sleep and raise your family for many years to come.

The most common item that is looked at in the mortgage is the length. Mortgages tend to come in standard lengths of 15, 20, 30 and even 50 years (though the 50 year mortgage is very new to the market). This represents the amount of time you will be making regular, monthly payments. 30-year fixed and 15-year fixed is the two mortgages you will see offered by most lending institutions. The term fixed means that for the specified number of years you will make a fixed monthly payment.

While we are on the subject of lengths and payments let’s take a few moments to look at equity when it comes to your home and mortgage. Equity is the real dollar amount of how much of your home you “own” without any liabilities (such as the mortgage) against it. Equity builds slowly in a mortgage as you are paying primarily on interest for the first few years. It then begins to build at a faster rate the longer you get into the mortgage and more of the monthly payment goes against the principle instead of interest. Naturally, the shorter the length of the mortgage note the quicker you will build equity.

Speaking of interest you probably already know what interest rates are. The lower the interest rate the less you will pay in the long-run for the house. Interest rates are based on various factors including current economic conditions and your credit score. They can also be based on the amount of down payment you have and the length of the loan. Points also play into interest rates and are a phenomenon of the U.S. housing market. Points are a fee you pay upfront for the mortgage directly to the lending institution. Points represent percentages and are based on each increment of $100,000 borrowed. So you may see a mortgage that lists an interest rate of 6.25% and 3 points or 7.5% and 0 points. This means that you can get the mortgage at 6.25% if you pay $6,000 upfront on a $200,000 house or you pay 7.5% and pay nothing upfront. Points should not be confused with your down payment which is separate.

When talking with your realtor or banker you may hear the term ARM or Adjustable Rate Mortgage being used. These are popular during times of high interest rates and basically mean that during the life of the mortgage the interest rate may be adjusted. ARM interest rates are typically lower at first but may be adjusted up and down during the life of the loan. They are tied into short-term Treasury bill rates to determine interest rates.

Although we’ve only given you a brief introduction to the world of mortgages (and there are many other options available out there) we have tried to hit upon the common mortgage types you will find. Of course, the best course of action is to discuss with your lending company and financial advisor before deciding on any type of mortgage choice. They can help you make an informed decision based on your current financial situation.