Choosing the loan program can be nerve wracking for most people. You want the lowest rate and lowest payment, but want to feel comfortable that you have made the right long term decision. Of course, you can have any program you qualify for – but you need to feel comfortable with your choice. Here are a few questions, and the result will help to guide you towards your choice.
#1 All Things equal, how long do you anticipate living in the home? Take into account that you just graduated, or you move around a lot, or that you have lived in the same house for 20 years and are not going anywhere.
The key here is to match your duration (how long you will be there) to the duration of the loan. If you only believe you will be in the house for 3 years – maybe a 3-5 year arm is a good idea. You are not staying in the house for 30 years, then why would you pay for the time value of money on a 30 year loan?
#2 How stable is your income? A high stable income (relative to the loan size) might be great for a 10-15 year mortgage, while a low relative income might bring value to the 30 year fixed program.
#3 How is your rational risk taking? This is the hard one, but the one that most likely will decide your choice. It is rational to take a 3% 5-1 ARM over a 4% 30 Year Fixed if you are only planning on being there for 4 years. On a $300,000 loan (payment of $1264.81 vs $1432.25) in 4 years you would save $167.44/mo. ($8037.12!) AND your payoff would be lower as well (due to area under the curve savings) a balance of $273,780.11 vs $277,540.48 for additional savings of $3760.37 – a total savings of $11,797.49 over 4 years! (You can recreate all of this by using our mortgage calculators)
Even if you are risk averse, you could take the lower ARM, and send in the payment as is you had the higher fixed rate – You balance in 4 years would be $265,440.49 a savings of $12099.99 over the same 4 years.
Then there is the 15 vs 30 debate. Can you absorb the risk of the 20% higher payment to save a lot of funds over time? Let’s take a 15 year fixed (at 3%) vs the same 4% 30 year fixed loan. The payment on the 15 year fixed is $2,071.75. Doing the math the total payments are $372,915 vs $515,610 for a savings of $142,695! Sure some of that is going to be discounted (heavily) by the time value of money, still in nominal terms it is a huge difference. If we take out the original $300k – its interest of $72,915 vs $215,610. Not only is that nearly 3X the interests, it is almost the principal amount! (For the 30 year)
We could go on forever, but it’s best to not over think it. Be as rational as you can, otherwise you are paying a premium for being irrational. The banks are counting on it, don’t be that gal!