United States: Which Mortgage Option Is Best For Me?

Purchasers face a big challenge in choosing a mortgage. How do you know which mortgage option is best for you? Even if economic experts could agree about what will happen to interest rates during the next year, you should stay as informed as possible about the options available to you. Let's discuss some of the mortgage instruments currently used nationwide as well as some of the features of those mortgages.

The most popular and traditional mortgage is the fixed-rate, which involves making regular payments based on a fixed interest rate. First time buyers and financially motivated buyers often choose fixed-rate mortgages because they want the security of stable and affordable payments. Fixed-rate mortgages also reap the greatest cumulative tax deductions available over the loan term.

Generally, lenders require 25 percent down payments on conventional fixed-rate mortgages, but with Federal Housing Administration (FHA) insurance, in come cases only 5 percent is required.

A twist on the 30-year fixed-rate mortgage is the shorter-term fixed-rate mortgage, with either a 10-or 15-year loan term. These shorter terms require larger monthly payments than a 30 year term, but the benefits that often attract buyers include the lower interest rates, faster equity buildup, and a substantial interest savings over 30 year mortgages.

With biweekly fixed-rate mortgages, payments are about one-half that of monthly fixed-rate mortgages with the same amortization schedule, and they are drafted automatically from the borrower's bank account every other week. Borrowers make the equivalent of 13 monthly payments in just 12 months, and as a result, they save on interest, and their equity builds faster. Biweeklies amortize every two weeks rather than monthly, and loan amortization terms of 10, 15, 20, and 30 years are available.

Adjustable-rate mortgages (ARMs) are a little riskier that fixed-rate mortgages. In exchange for lower initial interest rates, a borrower takes the risk that if lending rates rise, payments will also rise.

With ARMs, rates are adjustable during the term of the loan according to changes in market interest rates. Borrowers typically choose a one-or three-year ARM, and as the names imply, the rate remains stable for the first year, or three years. A per adjustment cap and a lifetime cap on the level to which the interest rate may be adjusted can help reduce some of the risk, and these are available on some ARMs, as are 15- and 30- year loan terms, and options to convert to fixed-rate mortgages.

If you expect to move within a few years, an ARM would be a good option because of the low initial interest rates and the resale of the property before the rates are adjusted. Many people refinancing their current mortgages may also choose ARMs if the lower initial interest rates can make up for the transaction cost of refinancing.

Remember that lenders use different indexes on which to peg their ARMs. The index used will determine the payments during the loan term. For example, some lenders use the cost-of-funds indexes that are tied to the interest rates on savings accounts whereas others use the six-month or one-year U.S. Treasury securities index.

Before making a final decision on a mortgage speak with your mortgage broker, banker, accountant or your attorney to discuss your particular needs and to help determine which type of mortgage will be best for you.