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What Kind of Mortgage to Get

by Keith Rawlinson
Volunteer Budget Counselor

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

This article copyright © 2007 by Keith C. Rawlinson (Eclecticsite.com).  All rights reserved.
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