Choosing the Right Mortgage
Perhaps the single biggest decision you make when buying a home (other than picking the home itself) is finding the right mortgage. The "right" mortgage will get you the right payment options, the right interest rate and the right lender to work with. The wrong mortgage? Well, you could end up with trouble with a bad lender; you might end up paying thousands more if your interest rate is too high; and with the wrong payment options, you won't be able to get rid of your mortgage as quickly as you'd like. And after all, we'd all like to be mortgage-free faster, wouldn't we?
However, it can be very confusing choosing a mortgage. You have a lot of options! Do you want a traditional ARM? Do you want to lock in a rate for 3 or 5 or 7 years? Longer? Do you want to be able to have lots of choices in payment options? All these things require you to think about your spending habits, the kind of employment you have, and your tolerance for risk.
In most cases, the mortgage with the most flexible payment options gives you the most options in how you handle it. This can be especially useful if you have a type of "irregular" income, whether you are paid on commission or get a periodic bonus based on performance. If so, you likely want a mortgage that will give you the lowest possible regular payment (say a 30 year term) combined with the most generous extra payment options (say up to 25% of the total mortgage in a year, with no restrictions on amount, frequency or size of payment up to the 25% maximum). This kind of mortgage will allow you to pay off your mortgage as quickly as you can, while also giving you the security of knowing that you should be able to handle your monthly payment.
Perhaps you'd like to pay your mortgage off as quickly as possible, and you've just got a new job with a much higher salary. Well, in this case, you might actually want to shorten the term of your mortgage loan! The amount of money you will save if your mortgage is amortized over 15 or 20 years (as compared to a 30 year term) is astonishing. You can save tens of thousands of dollars. Of course, this approach will only work if you have the money to afford a larger payment and if you have the job security to allow you to take this approach without undue risk (like missing payments).
What if you took a shorter amortization last time you renewed your mortgage, and now you are finding the payments too high? It's time to talk to your lender. Many lenders will cheerfully renegotiate your mortgage (including a longer amortization period) if you are willing to lock in with them for a longer term. If you have 3 years left on a 5-year mortgage, you could offer to lock in for another 2 years (to give them another 5 year horizon with you) and they may then be happy to give you a longer amortization period as part of the deal. Most lenders will be very happy to work with you if you have a good credit history. Even if your credit history is a little spotty, your lender usually does better if you pay off your loan on time and regularly, than if they drive you into a foreclosure. Consider talking with your lender.
As for the majority of us, how do you know how to pick a mortgage? In general, stick with a 20 to 30 year amortization. This usually gives you a manageable payment. Also, consider your own tolerance for risk when picking a type of mortgage. The standard ARM mortgage gives you some predictability in interest rate as well as a chance to take advantage of lowered interest rates over time. However, it will also expose to you rising interest rates over time. This is the gamble with it. Most of us are willing to take some gamble in order to have a lower interest rate up front. This makes sense because your highest interest costs are also when your mortgage is at its largest amount. But you could end up with higher interest rates in the future, which will also mean higher payments.
If you don't like the idea of your payment changing as interest rates fluctuate, lock in to a rate for a longer term. You will pay more in interest for the privilege of locking in, but you will also know the exact amount of your payments for the full term of the mortgage, whether 3, 5, 7 or 10 years. Many people like this kind of security, and will find that their income goes up over the term of the mortgage, making life much more comfortable along the way.
So, keep in mind your life, your financial plans and your type of employment. Then, pick the type of mortgage that fits you.