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Choosing Your Best Home Mortgage Financing Option
By EchoBay Loans Staff Writer

For most people, buying a home is the single largest financial decision they will make. In order to make the decision wisely, you should invest time in researching your financing options to ensure you get the best home mortgage available. There are many different loan types to choose from in the market.

Fixed Rate Loans

30-Year Mortgage
This is by far the most common mortgage and the easiest to understand. Your loan amount is amortized over thirty years at a fixed interest rate with a payment that remains the same over the life of the loan.

Pros: Cons:
Payments are generally lower than other options because the amortization period is longer. A longer amortization period equals more interest paid.
Your payment and interest rate is fixed for the life of the loan. If you purchased your home when rates were high, you’ll continue to pay the high interest rate even when rates drop.
For the first few years, the majority of your payment goes to interest that could result in a large tax deduction. It takes longer to build equity in your home.

15-Year Mortgage
This mortgage is based on the same principles of the 30-year mortgage with the main difference being the loan is amortized over fifteen years rather than thirty.

Pros: Cons:
Less interest is paid because the amortization period is shorter. Payments can be considerably higher than those of a 30-year mortgage.
Your payment and interest rate is fixed for the life of the loan. If you purchased your home when rates were high, you’ll continue to pay the high interest rate even when rates drop.
Build equity quicker than with a 30-year mortgage. You will not have as much tax-deductible interest to write off.

Adjustable Rate Mortgages
Adjustable Rate Mortgages, commonly referred to as an ARM loan, has an interest rate set for a certain period of time. After that time period, the interest rate usually adjusts on an annual basis. The interest rate is tied to an index such as the one-year Treasury Bill. The lender then adds a margin, which results in the interest rate:

(Index + Margin = Interest Rate)

The payment on the ARM loan adjusts when the interest rate adjusts. Depending on the periodic and lifetime caps that are in place, your payment can be dramatically increased with this type of loan if rates skyrocket. There are a variety of financing options with ARM loans. They are commonly referred to as 3/1, 5/1, 7/1, etc. The first number represents how long the initial interest rate is set while the second number indicates how often the adjustment period is. One year ARM loans are also available where the initial interest rate is only set for one year and adjusts annually thereafter. Typically, the shorter the set initial period, the less the initial interest rate is.

Pros: Cons:
Payments can be very low in the beginning when discounts are often offered. Payments and interest rates are variable. When rates skyrocket, so does your payment.
Many can qualify for a more expensive home because payments are lower in the beginning. When rates increase, the payment may no longer be affordable.
Options can be added to convert the loan to a fixed rate loan at pre-set times. There is usually a fee for this in addition to paying traditional closing costs again.
Payments caps can be set so that the payment never increases over a certain % at each adjustment. If the payment does not cover all of the interest, it can result in negative amortization. This can cause you to owe more than you originally borrowed.
ARM loans can be the best solution for those who plan to only be in their home for a short period and can take advantage of a low rate for the initial set period. Plans sometimes change and when the adjustment period rolls around, you could be looking at an incredible increase in the interest rate.

Other Financing Options:

No Money Down
This option is especially popular with first-time homebuyers. With these programs, you can put little or no money down. This often allows those who would be unable to enjoy the dream of home ownership because of the required 20% down payment to purchase a home sooner.

With this option, the lender must protect itself against the additional risk when buyers do not invest money of their own. In order to do this, Private Mortgage Insurance (PMI) is purchased. PMI is paid for by the buyer and generally ranges from $50-$120 per month. It is important to realize that while the buyer pays the premium, the lender is the only one protected.

Pros: Cons:
Home ownership can be obtained sooner. Total payment will be higher because of PMI and you may not qualify for as large of a loan.
Home can be bought with little or no money down. PMI must be paid to cover the risk of the lender.

Piggyback Loan
This option is available for those who do not want to pay a 20% down payment and want to avoid PMI as well. With a piggyback loan, you will have a second loan in addition to your primary mortgage. Typically, it is an 80-20 piggyback loan meaning that the primary mortgage is 80% of the purchase price and the piggyback loan is the remaining 20% of the purchase price. If you are willing to put down 10%, the loan can also be structured as a 80-10-10 loan (80% primary mortgage, 10% piggyback loan, 10% down). The piggyback loan serves as your down payment thus helping you to avoid PMI.

Pros: Cons:
Home ownership can be obtained sooner. Total payment can be higher because of paying on two loans.
Home can be bought with little or no money down. You may qualify for less of a home because of the additional payment.
Interest for both loans is tax deductible where PMI costs are not. Interest rate for the second loan is usually variable and at a higher rate.

Bi-weekly mortgage
This option can generally be set up with any existing loan without using a costly service. Rather than paying your payment monthly, payments are made once every two weeks. With 52 weeks in a year, this results in 26 payments, which is the equivalent to paying 13 monthly payments per year. The 13th payment is applied straight to principal and can have an incredible effect on your ability to pay the loan off sooner.

Dividing your monthly payment by 12 and adding that amount to your regular monthly payment can also accomplish this. For example: payment of $600 per month divided by 12 is $50. Instead of paying $600, pay $650 and by the end of the year, it is the equivalent of an extra payment. You will need to check with your lender to find out the best way to send in payments to ensure they are credited properly.

Pros: Cons:
Typically a good option for those paid bi-weekly. Can cause problems if unexpected expenses arise because payments are so close together.
Can shave several years from your mortgage using this method. It can be tedious to ensure your lender is applying your payment properly.

As you can see, there are many options available. Ultimately, the best home mortgage is the one that fits your needs and your willingness to accept risk. Your lender is a great resource and can lay out the options based on your financial situation so you are able to make an educated decision.


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