There’s more to figuring out how much home you can afford than just the price of a house or condo. First, you need cash set aside for a down payment. Then you need to determine how much you can afford for a monthly mortgage payment—and typically, the lower your interest rate, the lower your monthly payment will be.
The first step in finding the lowest mortgage interest rate is to decide between an adjustable rate mortgage (ARM) and fixed rate mortgage:
Adjustable Rate Mortgages
You’ll usually get a lower interest rate with an ARM—at least for starters. The typical ARM is a “5/1” ARM, which means the original interest rate stays constant for the first five years of the mortgage, and then it adjusts each year after that, to keep pace with changes to borrowing rates. Your rate (and your monthly payment) could go up or down. Keep in mind that ARMs typically have caps that limit rate or payment increases. Be aware of them when you’re comparing loans.
Fixed Rate Mortgages
As simple as a loan can get: Your interest rate never changes, whether you sign for 10-, 15-, 20- or 30-year terms. The longer the term, the higher the interest rate (the swing between a 10-year loan and a 30-year loan can be as much as a full percentage point or more).
What’s the right choice for you?
You absolutely want a loan that will affordably get you into the home you want—and of course, keep you there. So most often, the choice between ARM and fixed rate comes down to one question: How long do you expect to stay in the home you’re buying?
ARMs can be perfect if you’re looking for a starter home that you expect to outgrow and sell within four or five years. You get the lowest possible interest rate, and get out of the mortgage before it has the chance to adjust upward.
On the other hand, a fixed rate may be the right call if you expect to stay in your home longer term. Every month, your combined principal and interest add up to the same amount and will never change over the term of the mortgage.
How low can you go?
Whether you have an ARM or a fixed rate mortgage, you can reduce your monthly payment by refinancing your loan if rates drop sufficiently—and you plan to stay in your home long enough to make it worthwhile.
One more point to make
As you shop for a mortgage, you’ll hear a lot about “points.” Points are a prepayment that reduces your overall rate and monthly payment. We’ll go into more detail on that in a future blog post.
Whether it’s a starter home, a second home or a refinance, connect with us and we can guide you through the mortgage process from pre-approval to closing.