Managing your biggest asset your home is really about managing your mortgage, your biggest debt. That's why you'll want to select a loan that fits both your budget and your lifestyle. Keep in mind that reducing your borrowing costs wherever you can is an important part of the home-buying process. After all, a home doesn't pay for itself. You pay for it.
Find the right fit. Whether you choose a fixed-rate or an adjustable-rate mortgage depends a lot on your future plans, especially how long you plan to stay in your home. The longer you plan to live in the house, the more a fixed-rate mortgage makes sense.
- Plain vanilla. A 30-year, fixed-rate mortgage is the most basic loan, and it's your best choice if you plan to stay in your home a decade or more. But over the long haul, these mortgages are really expensive. If you were to get a $200,000 mortgage today with a 5% interest rate, you would pay $185,000 in interest over the life of the loan, in addition to the $200,000.
- Slow and steady. While you pay the same amount each month for a fixed-rate loan, you pay most of the interest costs first, which means your repayment of principal will be excruciatingly slow. If you don't pay anything extra, it will take you more than 10 years to pay off the first $50,000.
- Shorten the term. You can pay off the mortgage faster simply by adding an additional amount to your payment every month or every year, or you can start with a 15- or 20-year mortgage. You'll have higher monthly payments but you'll pay substantially less interest over the loan's life.
ARMs length. Adjustable-rate mortgages, or ARMs, make the most sense if you plan to move within seven years or less. Then, you can take advantage of the ARM's lower initial rate, while avoiding worries about how the interest rate on the loan might climb once it starts adjusting.
- Flex pay. With an adjustable-rate loan, you're likely to have a lower monthly payment and pay less annual interest. But your chances of actually paying off a home are slim because you'll be restarting the mortgage clock every time you move.
- Go long. Focus on ARMs that adjust after five years or more and avoid loans that adjust after the first year or two. With the latter, you could end up with substantially higher payments not long after you get all the boxes unpacked.
- Confront the worst case. Calculate how large your payment will be if the interest rate rises to the highest level allowed. If you can't afford that payment, you should consider a different kind of loan. Use our fixed vs. adjustable rate calculator.
Fine print. Pay attention to the various additional charges. Origination points are just another fee, with one point equal to 1% of the loan. Discount points are charges you pay upfront to reduce the interest rate you pay.
- Discount deals. Discount points can be a good deal if you can recoup the cost of the points while you own the home. Using an online mortgage calculator, figure out how long it would take for your interest savings to exceed the cost of the discount points. If you plan to be in the house at least that long, it's a good deal.
- Penalty payments. Some lenders charge a steep prepayment penalty if you refinance or sell your home in the first few years you own it. Generally, these are a bad deal, but they can pay off if you get a lower interest rate in exchange for agreeing to the penalty.
What not to do. Given that a mortgage is your biggest obligation, you want to proceed with caution in deciding how much you can comfortably borrow.
- Don't let debt drive. Debts should help you meet your goals, not get in the way of them. You should never have to decide whether to pay the house note or pay into your retirement plan.
- Don't be seduced. It's so tempting to borrow just $10,000 or $20,000 more to get another room or the cuter house. Don't forget that it's still real money. You'll pay a little more every month, which adds up to a lot more year after year.
- Don't pay origination points. You'll pay plenty in fees for the appraisal, title insurance and closing costs without paying for these.
Adapted from The Wall Street Journal. Complete Homeowner's Guidebook, by David Crook, (Three Rivers Press, 2008).