For first-time home buyers, the process can be pretty overwhelming. Are you supposed to look at houses first or find a lender? Do you go with a cost-effective fixer-upper or a more expensive, move-in-ready home? And we haven’t even mentioned all the different types of mortgages. Basically, if you’re feeling confused about the home-buying process, you’re not alone.
When it comes to mortgages, it’s important to know that mortgages are essentially a product. And just like you wouldn’t purchase a new TV from Best Buy without comparing prices from Walmart and Amazon, mortgages should be shopped for and evaluated before you sign your X on the line. Some types of mortgages work better for certain people, while others would not be a good fit.
Fixed Rate Vs. Adjustable Rate
Your lender will help you determine which type of mortgage you qualify for (i.e., conventional or government-backed) and which one will best suit your needs. But once you know the type of mortgage you’ll use, there are certain choices you’ll need to make, such as deciding between a fixed-rate mortgage or an adjustable-rate mortgage, as well as the length of the loan term.
A fixed-rate mortgageis a loan with an interest rate that stays the same over the loan term, so the monthly principal and interest payments will never change. Although you’ll typically pay more in interest, you can be sure your monthly payment will stay the same.
On the other hand, an adjustable-rate mortgage (ARM) may begin with a fixed rate for a period of time (such as 7 years), but then transitions to an adjustable interest rate that can go up or down each year depending on market conditions. ARMs come with a lower initial interest rate, but with the risk that monthly payments become unaffordable if the rate increases too much.
For this reason, we recommend a fixed-rate mortgage for most home buyers. Although not the cause of the 2008 housing market crash, ARMs contributed to many foreclosures, and a lot of people weren’t able to continue making payments when interest rates increased. (1)
Deciding Your Mortgage Term
You also need to determine the length of your loan term. The most common mortgage term for purchasing a home in the U.S. is 30 years. (2) This term length is viewed as one of the least risky options for lenders, and it allows homeowners to enjoy smaller payments each month that make owning a home more affordable.
The second most common term length is a 15-year mortgage. Shorter terms result in lower interest rates but higher monthly payments. For example, consider the difference on a home selling for $1,000,000 with a 20% down payment. The 30-year term might come with an interest rate of 4.1%, while the 15-year term might only be 3.4%. The 15-year payment might be as high as $5,680, while the 30-year payment might only be $3,866 a month. (3)
So What Loan Term Is Right For You?
The answer to this question depends entirely on what you can afford and what else you plan to do with your money each month. The 30-year mortgage may allow more people to become homeowners, especially in expensive areas like California or Colorado. And, if you’re investing money each month that earns returns higher than the interest rates on your loan, you might end up making more money in the long run.
On the other hand, the 15-year mortgage allows you to pay off a home in a much shorter period of time with less interest. The 15-year mortgage might allow you to keep a home that is paid for and rent it out while you purchase another home with another 15-year mortgage term. In some cases, this could allow you to own two homes completely paid for by the time you retire!
Partner With A Professional To Help You Make These Decisions
For most home buyers, we recommend a 30-year fixed-rate mortgage. However, choosing the right mortgage depends on a multitude of factors, such as your values, your plans for your wealth, and your means of growing your wealth. An experienced financial planner can help you weigh the pros and cons of your options, resulting in a decision that optimizes your opportunities.
At Haydel, Biel & Associates (HBA Wealth), we practice values-based financial planning, so we can help you determine the best choice based on your unique situation. Please contact us at (626) 529-8347 or email Ricky at email@example.com. We look forward to hearing from you!
About Haydel, Biel & Associates
Haydel, Biel & Associates is an independent financial advisory firm serving individuals and families near Pasadena, California. The firm was founded in 2004 by Chris Haydel and Ricky Biel with a desire to provide unbiased, client-centered, community-based financial advice. Together, they have built a practice that has grown into a family of caring, smart professionals committed to blending proven investment methodologies with creative financial technologies that make it easier than ever to accomplish your goals. They strive to keep things simple and fun to give their clients peace of mind and alleviate financial stress. HBA Wealth takes care of their clients’ needs first and foremost and goes the extra mile to make their clients’ finances grow. To meet and see how the HBA Wealth team may be able to help, contact them today at (626) 529-8347 or email Ricky directly at firstname.lastname@example.org.
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