Even though I advocate being debt free, a home mortgage, unfortunately,
is often a necessity in America today. I would love to see
people
never have to borrow money for anything, but without a mortgage it
would take far longer than is realistic for
most people to be able to buy a house. Although it may be
necessary to get a mortgage in order to buy a house, it is important
that you not get more
mortgage (more house) than you can afford and that you get the
right kind of mortgage. Before we talk about what kind of
mortgage you should get, let's first discuss what kind of mortgage you
should not get.
The wrong kind
of mortgage.
Here are the two most common mortgage loans that I see get people into
a lot of financial difficulty:
Interest-only mortgage
Never, ever get an interest-only mortgage. These mortgages,
in my
opinion, are becoming far too popular. They are popular
because
they allow people to make a relatively small payment if they wish.
Unfortunately, people generally fail to see the dangers
of an interest-only mortgage. For one thing, these mortgages
tend
to get you in the bad habit of only paying that minimum, interest-only
payment. When you do this, you are not paying down the
balance of
what you owe, and you can never get out of debt paying this minimum.
Also, these mortgages generally either convert to another
type of
mortgage after a certain period of time, or they have a balloon
payment. A balloon payment is when you are required to pay
off
the entire balance of the loan all at once. You either have
to
have the cash on hand, or you have to hope you can borrow it somewhere
else.
An interest-only mortgage just goes completely against
everything
I teach. They're bad news. Stay away from
interest-only
mortgages.
Adjustable Rate Mortgage.
I also recommend that you do not get an adjustable rate mortgage, also
known as an ARM. These mortgages start out at a nice, low,
tempting interest rate, but adjust as the prime interest rate changes.
Most often, people get these ARM loans because they can
afford
the smaller payment they have initially. Or, even worse, they
use
the lower initial interest rate to buy a bigger house than they
otherwise would. The problem is that if these ARM loans
adjust
up, and they usually do, your payment can more than double!
Imagine getting an ARM loan with a low initial interest rate
and
having a payment of $600 per month. Then, a few years down
the
road, the rate has adjusted up to the point that your payment has
become $1,300 per month! It happens. And, sadly,
when this
happens it is usually at a time when you are financially very tight,
can't afford the increased payment, and might not be able to qualify
for a new loan to pay off and get rid of the ARM loan. If you
get
an ARM loan when interest rates are otherwise relatively low, the
interest rate on your ARM mortgage will seem really, really low.
And it is--for a while. Think about it; when
interest rates
are at a relative low, which way are they most likely to go from there?
Higher! Even if they go lower temporarily, they
won't stay
at a relative low for the next fifteen or thirty years, so eventually
your mortgage payment will most likely be going up--perhaps by
quite a bit. Over time, the payment you start
with may double or even triple! If interest rates are at a
high when you get your ARM, what
happens if they go up even higher from there? Anyone remember
some of the 18% mortgage loans of the 1980's? The rates would
probably start back down from a relative high eventually, but can you
afford those increased mortgage payments while you are waiting for that
to happen? Please stay away from adjustable rate mortgages.
The right kind of
mortgage.
First of all, if you can, I recommend paying cash for a house. Most people can't, but if you can pay cash, please do!
If you can't pay cash for a house, then the only mortgage that the average person should consider is a fifteen
or thirty year, fixed rate mortgage. In my article What Can You Really Afford,
I talk about keeping your monthly mortgage payment to around 20% of
your monthly take-home pay. At the very most, your monthly
mortgage payment should not be more than 25% of your monthly take-home
pay. If you can get a fifteen year, fixed rate mortgage and
still
keep your payments within these guidelines, then that may be the way to
go. A fifteen year mortgage costs you less in interest over
the
years, and gets you out of mortgage debt that much faster. If
a
fifteen year, fixed rate mortgage would put your monthly payment above
the 20% - 25% guideline, then go with a thirty year, fixed rate
mortgage.
With a fixed rate mortgage, your payment does not change during the
term of the loan. In other words, your payment stays the same
for
the next fifteen or thirty years depending upon which loan you get.
Your payment will not go down if interest rates drop, but it
also
will not go up if they rise. This allows you to plan your
spending and know what your house payment will be for the next fifteen
or thirty years.
What about if interest rates go down during those fifteen or
thirty years? Aren't you missing out on having your payment
adjust down as it would with the adjustable rate (ARM) mortgage loan?
Well, yes, but if the interest rates drop enough to really
matter, you can always refinance to another fixed rate loan and get
the new, lower interest rate. In doing this, you get back the
same 'advantage' you would have had with the ARM, without the risk of
the disadvantage (payments adjusting up). And if, when interest
rates drop, your
situation is such that you cannot qualify to refinance, you
also wouldn't be able to qualify for a
new
loan to pay off an ARM either--so, you would still be obligated to
pay those
higher ARM payments or lose your home!
Hopefully, you can now see the danger in having anything but a fifteen
or thirty year, fixed rate mortgage. After you get your
fixed rate mortgage loan, I recommend paying extra each month so that
you can pay the mortgage off early and be completely debt free
including your house! That's what my wife and I did.
It
sure was an incredible feeling to walk into the bank and pay our
mortgage off seventeen years early!
If you want a suggestion for where to get your mortgage, be sure to
check out the links on
the Financial Page.
Through wisdom a house is built, and by knowledge the rooms are filled with all precious and pleasant riches. Proverbs 24:3-4