Loan Question

We have finally decided to get the house we’ve been saving up for and we’re aware that we are supposed to get a mortgage. There seems to be never-ending terms and home-loan jargon that we don’t understand. Fixed rate mortgage vs. adjustable rate mortgage, which one to choose? While having a low monthly payment sounds ideal we are aiming for minimized amount of interest paid over a period of time.

You should be working with a professional, usually a mortgage broker, who can advise you on the various options available. Which one is the best for you will depend on your financial situation. Do you have a financial analyst? They could help you make the best decision based on your particular circumstances, otherwise you need to learn about it yourself.

Given the extremely low (historically) rates on 30-year fixed mortgages, if I were you, I’d lock one of those in. Adjustable-rate mortgages are good when rates are fluctuating, especially if they are high and likely to go down, which is not the case now.

The BEST advice I can give you is see if you can manage to handle a 15-year fixed. You can actually make a dent in the principle of the loan in a fairly short time. Making headway against a 30-year fixed is like swimming through molasses in January. :frowning:

That’s what I did when I refi’d a few months ago. The broker barely got the word ARM out and I asked him (kinda sarcastically) if he really thought the rates would go lower than 3.75% (where I was locked). I mean, I know they can, and they had already come up a little bit from when I first started looking, but realistically, they can only go down so far.
Personally, I’d be willing to bet (and I took the bet) that in 5 years or 7 or 10, that the rates would be higher than they are right now so I took a conventional mortgage.

That’s a tough one. I went with a 30 year, but I pay enough extra that if I pay this amount, every single month, my mortgage will be paid down in 15 years*. But, should I need the money for something else, I’m not in trouble, it’s just there.

Checking online, with current rates, a 15 year mortgage would add about $300 a month. I pay, off the top of my head, about that same amount but have the advantage of, like I said, just not paying that should I want to divert that money elsewhere if I need/want to.

Something else that’s important if you do anything ARM related, make sure your payment includes principal. Sometimes people have an interest only payment (wow, it’s sooo low!) and have no idea that after making years of payments they’ve still owe, literally, the same amount.

Aiming for minimum total interest over the life of the loan is the wrong goal. If you think you want that you don’t yet understand enough to pick which loan is really best for you.

You’re actually wanting to minimize total cost over the life of the loan corrected for the time value of money. $100 of interest paid this month is far worse for you than $100 of interest paid 27 years later. Simply totaling up all the interest payments is the wrong way to figure it.

The other thing you want is to minimize your risk of default.

The bigger the payment, the smaller the economic setback you have to suffer before you default. For example if both you and your spouse work, do you want to take a mortgage you can only afford while both of you have jobs? Or do you want one where only one job is needed to cover? How stable are your jobs? How many times will you expect to change jobs (but live in the same house) over the next 10, 15, or 30 years? What happens if your best estimate turns out to be wrong?

There are more things to consider but these are the big two IMO. Be forewarned that the real estate sales and mortgage origination industries are both more than glad to help you tie a noose around your financial neck. Whatever they tell you is “the max you can afford”, the true number (given any bad luck at all) is barely half that.

One thing you should consider is the total amount that you will pay, including interest and fees, before the house is yours.

With current low interest rates you should aim to pay off as much as you possibly can early on, to reduce the principal and allow more flexibility later if you get into any difficulties.

I agree with what Joey P. said above. I bought my first place a few years ago, and I went with a 30 year fixed mortgage. I could have afforded a 15 year, but like the flexibility that the 30 year gives me.

I’d suggest going to a bank in your area, preferably your current bank, and talk to a mortgage broker. I did this before I really started looking for a place. He walked me through the options, the approximate payments, the anticipated closing costs, and the steps to expect to go through when buying a house. Those steps included lots of inspections and other things that I didn’t necessary know about. Just because you talked to that mortgage broker at the start, it doesn’t lock you into getting the mortgage from them.

I would amend that to talking to a credit union in your area. I first bought through my bank, and it was fine - nothing to complain about. But when I did my refi a few years later when rates dropped, I went through a credit union on referral through a friend. They were far more flexible with me, and had more options available. My realtor was amazed at the expediency and flexibility to the point that she only recommends going through them now.

If you have to ask this question, you should get a 30-year fixed-rate, with as much down as you can afford while still leaving you an emergency fund (3-6 months expenses). You can always pay it down sooner, or re-finance to something more exotic if you learn enough to decide that’s appropriate for you.

This actually doesn’t make much sense: when interest rates are low, you may well be better off investing that extra money in something else valuable that will pay off at a higher rate.

All good advice.
You should also play around with an amortization calculator and try various loan amounts, terms, and rates and see how they affect what you’ll be paying. The amortization schedule tab on that same link will let you see your principal balance at any point during the loan also.

Going back to 1971 you’ll see the lowest ever mortgage rates were 2016 (3.65%) and 2012 (3.66%). If you get an ARM you’re essentially betting that sometime during the term of the mortgage, you’ll be able to beat today’s long-term rate, and refinance to a cheaper long-term mortgage.

OTOH, when it comes time to refinance, and the interest rates turn out to be more like 1981 (16.63%:eek:), or 1993 (the lowest rates that decade, at 7.31%) or even as recently as 2009 (the lowest rates in that decade at 5.04%) then you’ll be anywhere from stuck to screwed.

With an ARM the question really is, “Are you feeling lucky?”

One big caution with ARMs is that the rate for the first year or two might be set lower than the rate based on the usual calculation. A “teaser” rate. So the rate will suddenly jump even though the basis never changed. This is okay if you’re planning on refinancing in that time frame. (Which would mean you’re expecting a very large rate drop. Which isn’t going to happen now.)

Trying to get a mortgage broker to tell you what the rate will be after the teaser rate for the current basis rate is impossible. I know from experience. Mortgage brokers, in my experience, are far from the best source of honest information. They were a large part of the 2008 catastrophe. They deliberately make the information obscure.

In short, with all the gotchas and the current rate situation, ARMs do not look good. (And they rarely ever do.)

ATR/QM rules (Dodd-Frank) make that much harder now. You should receive a Loan Estimate that makes information clear:

Note, if you don’t get an LE within 7 days of application, run to the hills and don’t look back.

^ This.

If you can, calculate an amount per month that you can pay “extra” which is to be applied to principal only. if you do this, you can cut years off of that 30 year fixed; sometimes as much as 15.
But Don’t Ever Refinance!!! It resets all clocks/calculations to zero.

Depends on what you’re doing. E.g., refinancing from a 30 year with 20 years to go to a 15 year. There’s a lot of very good reasons to refinance, the Math can get a bit complicated, but it can be sussed out.

We refinanced a couple of times and ended up owning the house in far less than 30 years and saving quite a bit of money. So much for your clock thing.

It’s not any sort of automatic reset thing at all.

Even with historically low rates, there might be a few situations where it would be advantageous to get an adjustable rate. For an ARM, the initial rate is lower than a fixed rate mortgage. And you can get a very low initial rate fixed for a short period (e.g. five years) before it becomes an adjustable rate. This could be a good idea if you plan on selling the property or paying off the loan within five years.

If you are going to be keeping the loan for more than five years, then a fixed rate is the way to go. A 15 year fixed will get you a lower interest rate than a 30 year fixed, but the monthly payments will be higher. You have to decided what is best for you.

Since the OP is looking for advice, let’s move this to IMHO.

General Questions Moderator

Well, there is the problem right there! :smiley:

If this is your first time buying a home, be sure to look into getting a first time buyer discount. For example, our first time buyer mortgage only needed 3% down.

When I first bought my house I asked about ARMs. My mortgage banker asked how long we were planning to keep the house* and when we said “I dunno, hadn’t thought about, a while I guess, I mean we don’t have plans to go anywhere”, she steered us away from them. She mentioned that they’re great instruments for people that are only planning to be hanging around for a 2 or 3 years and want to save money with the intention of using that saved money as a down payment on a new house**. (Or need the money for something more important…or want to take the bet that rates will be down in X years).

*Always keep in mind a that a mortgage broker/banker is in the business of selling mortgages. For most people buying/refi-ing a house happens a few times in a lifetime, for them it happens 10-20 times a month. Furthermore, it’s no big deal if it falls apart before closing or you default. Yeah, they want to get their ducks in a row to get you (and them) the best deal, but most people that don’t move often haven’t thought out that far in advance.

**When I bought my house it was 2010, we were just coming off the sub-prime mortgage crisis and while I understood what I was asking, and she knew I understood, I think she really wanted to push me away from an interest only 5/1 ARM on a house I wasn’t planning on leaving any time soon. Maybe (maybe not) rightfully so.
But still, whenever I hear people talking about getting a mortgage and they say something like “I heard of something called an ARM” or “…an adjustable something” or “a 5/1? 1/5?”. I have a ‘come here, let’s talk for a minute’ conversation. They’re not bad, but you do need to understand what you’re getting into…Especially if you have banker like mine, it’s like talking to someone on speed. You have to be good at math and understand what’s going on to keep up with her, but in short (to the uninitiated), it’s like saying ‘so, your car, you pay, what $200 a month for 4 years, pretend like in 2 years it’s going to go up to $250’ and see how they react. Not a perfect example but it get’s them to stop and understand that TANSTAAFL.