With the variety of mortgages available today, how can you find the best mortgage for your circumstances? The first step is to assess your financial situation honestly, including your goals, preferences, and tendencies.
Financial analysis should come first. Consider your:
- Income Stability – Can you confidently predict your income over time? If not, how much risk are you willing to tolerate?
- Total Debt and Expenses – Do you have, or will you soon have, other significant debt (like paying for college)? What are your current and projected monthly expenses, and your ratio of debt (total expenses) to income? 36% or less is preferred. You can check your credit score and read your credit report for free within minutes using MoneyTips' Credit Manager.
- Cash on Hand – Do you have down-payment money (typically 20%) and funds for other fees (closing costs, property taxes, etc.)? How much cash do you need to retain for emergencies like job loss (typically six months' worth of expenses)?
If after this analysis you decide you are not ready, focus your energy on how to cut expenses, and save and invest for a future house purchase.
Assuming you are still ready to buy, let's consider the basic types of mortgage:
- Fixed-Rate Mortgage – Payments stay the same over the length of a loan term, usually fifteen or thirty years.
- Adjustable-Rate Mortgage (ARM) – Payment varies over time, based on a fluctuating index plus a fixed margin, with a cap on adjustment. There are many variations of ARMs, varying in degrees of risk (unexpected larger payments) for reward (lower initial interest rates).
- Hybrid Mortgage - Contains fixed and variable elements — typically a fixed-rate for 3-5 years, then variable for the rest of the term.
- Interest-Only Mortgage – These loans were commonplace before the housing crash and, while rare today, are still available to affluent homebuyers with sterling credit. Typically issued for ten years, they provide the lowest possible mortgage payment, as no principal is paid down over the life of the loan. Note that interest-only loans are not considered "qualified" mortgages under new rules from the Consumer Financial Protection Bureau. This means that lenders issuing such loans are not protected from liability over defaults. It also means that odds are you will not qualify for such a loan unless you are so well off that you probably don't need the loan!
Finally, ask yourself questions about your habits and goals, and how they fit into your options.
- Duration – Do you intend to live in the house for a long time? If not, an ARM or hybrid will offer you lower rates during your stay. Longer stays and low interest rates make fixed rates more attractive. Consider points (essentially prepaid interest) if you have the money up-front and intend to stay past the break-even point.
- Risk and Debt Tolerance – Do you prefer lower payments with higher potential risk, or would you rather pay higher prices for stability? Fixed-rates offer stability at higher rates. ARMs and hybrids come with higher risk — if short-term savings appeal to you, select the style of ARM that matches your risk tolerance level.
- Cash Flow – If you prefer minimal monthly payments for cash flow purposes today, and can risk potentially paying more over time, lean more toward ARM's and hybrids. On the other hand, if you would rather minimize the interest you pay over the term of a loan with certainty, go with a fixed-rate mortgage and the shortest term you can afford. If you cannot afford a 15-year payment schedule, go with 30-year and make extra payments toward the principal.
- Qualifications – Do you qualify for programs like VA or FHA loans? Both allow lower down payments compared to standard loans. If you do not have sufficient down money, another route is an 80-20 loan (80% standard mortgage with a higher-interest short-term loan for the 20% down money) — but this carries far more risk.
To summarize, the important steps in finding the right mortgage for you are to assess your situation, your goals and priorities, and your financial tolerances, then choose the type of mortgage that fits your situation and shop around for deals. Seek professional advice to answer any questions.
We can't guarantee to match you up with the ideal mortgage — but this advice should increase your odds, and make the journey to home ownership a little more pleasant.