For most people, buying a home is the largest financial transaction they will ever make. In fact, most people cannot afford to purchase a home outright and must therefore obtain a home loan for hundreds of thousands of dollars. By obtaining such a home loan, people commit themselves to paying off not just the principal amount but also years of interest. In reality, the amount you pay in interest can be just as much, or more, than the amount of principal. With this in mind, it is clear that choosing a home loan is one of the most important decisions a person will ever make. You must be willing to do your homework so that you can arm yourself with information that will help you to make the right choice.
Below you will find some of that information along with methods of obtaining more information. There is much more you need to learn above and beyond what is printed here, but hopefully it will give you a jump start.
The first thing you must be aware of is that the financial world and the legal world have joined forces to confuse you in the realm of mortgages. You will realize this the moment you pick up some informational document and are instantly pummeled with indecipherable legalese and financial boilerplate. However, you must never let this confusion deter you from getting all of the relevant information. You are the one who will be obliged to abide by the documents you sign, and you therefore must understand what those documents say.
When you do not understand something, ask questions. If you still do not understand, ask again. Do not feel embarrassed because you are confused. The people you are dealing with understand the language because they use it every day. Make them explain everything to you in a way you understand. If they cannot explain it they may be hiding something or just don’t understand it themselves. Either way, you should not do business with anyone who cannot explain anything that may be confusing to you. Again, you are the one who will have to pay, not them.
15 or 30?
One of the most basic decisions you will have to make regarding your home loan is the timeframe you will have in order to pay it off. In general, the lifetime of a mortgage is 15 or 30 years. With a 15-year mortgage, the monthly payment will be higher but you will pay off the loan faster and in the end will pay much less interest. In contrast, a 30-year mortgage comes with lower monthly payments but takes twice as long to pay off and accrues more interest.
Example: If you were to get a 30 year fixed rate mortgage for $200,000 with an interest rate of 5% you will have a monthly payment of $1,073.64. It will take you 30 years to pay it off and in the course of those 30 years, you will have paid $186,511.57 in interest. In total, you will end up paying $386,511.57 at the end of 30 years for borrowing $200,000 today.
If instead you were to get a 15 year fixed rate mortgage for $200,000 at the same 5% interest rate, your monthly payment would go up to $1,581. However, in the 15 years it will take you to pay down the mortgage, you will have only paid $84,685.71 in interest. In total, the cost of the $200,000 loan today only comes to $284,685.71.
In the above example, choosing a 15-year mortgage over a 30-year mortgage means that although you are paying a little more than $500 extra each month, in the end you are saving over $100,000. When people decide on whether to get a 15 or 30-year mortgage, their main concerns are often just the costs each month and the total timeframe of payments. Do not make this mistake. You must also carefully consider the total savings you can gain or miss out on regarding this decision.
Fixed or Variable?
The next major decision regarding your home loan is whether you want to get a fixed or variable rate mortgage. With a fixed rate mortgage, you will have the same percentage rate for the entire lifetime of the loan. If the interest rate is 5% on the first day, it will be 5% on the last. As for a variable rate mortgage, your rate will change over time. You may start off with a lower interest rate than you could have obtained with a fixed rate mortgage, but over time the interest rate will change. Usually it will go up.
You may or may not save money with a variable rate and this can be a scary proposition for many people. With a fixed rate mortgage, you can calculate your monthly mortgage expense every month for the lifetime of the loan. With a variable rate, you do not have that security and a bad surprise may be waiting down the road.
Why would a person get a variable rate? Maybe they like to live on the edge. Maybe they like to gamble. Maybe they can only afford the lower initial payment at the moment and they hope that when the rate goes up they will be able to afford it. In any case, it is generally in your best interest to avoid variable rate mortgages if you can.
To learn about some important terminology regarding home loans you can check out the FDIC. As for other home loan decisions, you should never jump on any deal without comparing it to another deal. Never take the first mortgage offered to you without looking into other options. Make sure you are aware of all of the fees you will accrue and when they will have to be paid. Know how everybody involved makes their money and be aware that many of the people you are dealing with do not have your best interests in mind. A mortgage broker may show you many options but he may be concealing others because he is being paid by one company or another. A broker is not an agent and is not obligated to look out for your best interests.
In the end, the most important thing is that you get unbiased information, understand what you are dealing with, and look for as many options as you possibly can. Remember, you are committing yourself to paying a debt for a good portion of your life. You can never have too much information regarding this decision.