Becoming a homeowner for the first time is both an exciting and stressful time. You can easily become overwhelmed with the entire process, including finding a home within your budget, applying for a mortgage, and then closing on the home. Before beginning the process, it’s important for first time buyers to understand how different mortgage loans work.
Fixed rate mortgages are the most common type of mortgage loans. Generally, you choose between a 15 or 30 year loan, with an interest rate that will not fluctuate for the duration of your mortgage. This type of mortgage is great for someone looking for a low interest rate plan.
Adjustable rate mortgages (ARMs) are best in a high interest rate environment. If you believe interest rates to be abnormally high, then you would not want to lock yourself into a high interest rate for the entirety of your mortgage. The ARM would be a great alternative because if you are correct and interest rates begin to fall, then the interest rate on your mortgage would drop as well. It is very important that you realize if you are wrong and interest rates continue to rise for a substantial period, your interest rate on your mortgage will rise as well.
The hybrid mortgage loan is a combination of a fixed rate mortgage and an adjustable rate mortgage. Depending on your financial institution, the mortgage will give you a fixed rate for a certain number of consecutive years and then the rate will adjust itself each year from then on.
Optional ARM mortgages are the least common of the four; however, they were quite popular between lenders and borrowers in the early 2000’s. Once again it depends on the financial institution that you secure your mortgage with, but the optional ARM mortgage usually offers multiple payment options each month that range from full interest and principal payments to a very low interest payment.
Becoming pre-approved is an important aspect of home buying that is often overlooking. Once you have decided what kind of mortgage best suits you, seek out the different financial institutions that you would like to work with and get pre-approved. This can be tremendously helpful because it allows you to get an idea of what your price ranges should be based on current lending requirements, and will also allow for you to make an offer on a home. This eliminates the complication of finding your dream home, and then worrying about getting approved.
Finally, consider making the largest down payment that your financial situation will allow. Although it might feel good in the beginning to make a minimal down payment and have more cash in the bank, larger down payments correlate to smaller monthly payments and a significant decrease in the amount of interest you’ll pay in the long run. In addition to significantly decreasing your monthly payments and interest, a 20 percent down payment provides other benefits as well. It helps you avoid having to pay private mortgage insurance, commonly referred to as PMI. This is an additional fee that the borrower has to pay that protects the lender in situations where mortgage loans are considered higher risk.
Buying a home should be fun, but remember to do your homework and be as thorough as possible when selecting mortgage loans. These tips should help you have a great home buying experience.
Andi is a professor at a college in South Georgia and teaches students about economics and real world money. During his free time from grading papers he writes about the different types of mortgage loans that are out there that first time home buyers may not be aware of.