When buying a house, your two largest expenses are the money you borrow and the interest you will pay on it. Shopping for the best mortgage loan rates is not just smart, it’s the best financial move you can make. While each borrowing situation is unique, some type of loans are known to offer lower rates than others. To get the best rates possible, you’ll need to choose the right mortgage type for your situation, polish up your credit score and put down as much money as you can when you buy.
What Are Fixed-Rate Mortgages?
Fixed-rate mortgages are the most popular type of mortgage because the interest rate does not change over the life of the loan. This keeps your payments stable so that you can budget appropriately and not have any financial surprises down the road. When demand for something is high, however, prices rise. Unless you are have perfect credit and a large down payment, you’ll probably find that you’re paying a higher interest rate on a fixed-rate mortgage.
The most common terms for fixed-rate mortgages is 15 or 30 years, although you may also find a 10-year or 20-year loan available. A longer term on your mortgage means lower payments, but it will take you longer to build up equity in your home. This may not be an issue if you plan on staying in the home for the long term, but if you don’t have 20 percent or more equity in the home, you may wind up paying private mortgage insurance (PMI) for a longer period of time.
On a $180,000 fixed-rate 30-year mortgage with a four percent interest rate, your monthly payments will be $859.35 and you’ll pay $128,906 in interest. If you’ve only put 10 percent down on the home, you’ll wind up paying PMI for almost seven years. If that same mortgage was for only 15 years, you would wind up with monthly payments of $1,331.44, but you’d save $69,247 in interest over the mortgage term and you would only have to pay PMI for roughly four years.
If you’re set on taking out a fixed-rate mortgage, you’ll need to spend some time polishing up your credit and make a down payment of at least 20 percent to get the best rates possible. Even if your credit isn’t stellar, you might be able to convince the lender to let you pay some of the interest upfront in points at the closing to lower your interest rate over the life of the loan.
Do Adjustable-Rate Mortgages Offer Lower Interest Rates?
After an initial fixed-rate period, the interest rates on adjustable-rate mortgages (ARMs) can increase or decrease depending on the lender’s going rate. This makes them riskier for the borrower, but there’s more profit in them for the lender. To entice borrowers to opt for ARMs, lenders generally offer initial rates that are much less than rates on fixed-rate loans.
Typically, the fixed-rate period on ARMs is five or seven years, although some lenders offer three-year or 10-year ARMs. Once the fixed-rate period ends, the lender usually adjusts the rate once each year, although some adjustment periods are for six months. A five-year ARM with an annual adjustment period is called a 5/1 ARM, while a seven year ARM with adjustments every six months is known as a 7/6 ARM.
The lenders usually have caps set on how high the interest rate can go at the end of each adjustment period and also over the lifetime of the loan, but your payment can still rise significantly if those caps are met. Let’s say you take out a 5/1 ARM over 30 years for $180,000 at an initial rate of 3.5 percent. That would make your payments during the fixed-rate period $808.28. If your rate jumps to the cap of two percent in year six, your payments would rise to $1,022.02. A six percent lifetime cap is common with ARMs. If your interest rate jumped that six percent at any point during the life of the loan your payments would rise to $1,513.54.
If you plan on selling your home before the fixed-rate period ends, then an ARM might be the right choice for you. There is some risk. If your home doesn’t sell in time, you might have to deal with an expensive refinance. It’s also possible that house values in your area tumble, which would make it difficult for you to sell your home at the price you need and it could be expensive to refinance at that point with the lower equity in the home.
Is a Balloon Mortgage a Better Deal?
Balloon mortgages start out similar to fixed-rate loans and ARMs in that there’s a period where the interest rate (and the monthly payments) remain stable. At the end of the fixed-rate period, the entire principal balance is due in one lump sum. What makes balloon mortgages attractive to borrowers is that the interest rates are typically very low, and you may only have to pay back interest during the initial period. Like ARMs, though, there’s some risk.
Borrowers who are planning to sell their home before the balloon is due risk that the house doesn’t sell or that home values decrease. Those who take out a balloon planning to refinance when the lump sum is due run the risk of interest rates increasing between the time they take out the loan and when they refinance.
Are There Other Low-Interest Options?
There are a few types of government loans that might be the best choice in terms of interest rates if you qualify. FHA loans are designed for borrowers who have minimal down payments for their homes, while VA loans are only for some current and past members of the military. The USDA also has a loan program with specific requirements.
2 Point Highlight
To get the best rates possible, you’ll need to choose the right mortgage type for your situation, polish up your credit score and put down as much money as you can when you buy.
There are a few types of government loans that might be the best choice in terms of interest rates if you qualify.
