Which Mortgage Type is Right for Me?

Which mortgage should I choose, based on my home buying situation? This is a common question among home buyers, and with good reason. The type of mortgage you choose will have a long-lasting financial impact on you. After all, you will be making payments on the loan for many years to come (unless you sell the home or refinance the mortgage).

Before we go any further with this lesson, let me say that only you can decide which mortgage is right for you. I'm happy to offer you my input on the subject, but I don't want you to make any financial decision based on this article alone. These are just my own personal and professional views on this topic.

Which Type of Mortgage - Fixed vs. Adjustable

There are many different types of home mortgage loans available today. But nearly all of them all into one of two main categories -- they are either fixed-rate or adjustable-rate mortgage. Which one you choose has a lot to do with your future plans. We will talk about which mortgage is best for different situation in a moment. But first, let me explain how these two types of home loans work:

• With an adjustable-rate mortgage, or ARM, the interest on the loan will change at predetermined intervals (such as every three years, every five years, etc.). In most cases, this means an increase in the rate -- and a larger mortgage payment as a result. These loans get their name because of the period in which they adjust or "reset" to a different rate.
• With a fixed-rate mortgage, the interest rate stays the same for the entire life of the loan. For example, if you got a 30-year fixed-rate loan at 7% interest, it would have that same 7% interest rate after the first year, after the tenth year, at year 20, etc.

There's another popular mortgage option that's actually a combination of these two variations. It is appropriately referred to as a "hybrid" mortgage -- or, to be more specific, a hybrid ARM loan. This loan starts out with a fixed rate for an initial period, and then it adjusts at predetermined intervals after that introductory period. In other words, it combines certain aspects of both the fixed and adjustable mortgages (hence the term hybrid).

A common example of the hybrid ARM loan is the 5/1 option. It's common to see hybrid loans expressed in this way. The first number pertains to the number of years during the initial fixed-rate period. The second number tells you how often the mortgage rate will adjust after that period. So for a 5/1 ARM, you will have a fixed-rate for the first five years, but after that the rate will adjust every year. There are also 3/1 ARM loans, 7/1 and 10/1 options. Those are the most common.

Choosing the Right Mortgage

Now we get back to the question we started this article with -- which mortgage option is right for me, given my home buying scenario? Keeping in mind the disclaimer I made earlier, let me say this...

• If you plan to stay in the home (and therefore keep the mortgage loan) for many years, you should strongly consider the fixed-rate mortgage. It offers predictability in terms of the interest rate, and that can be a good thing to have over the long haul.
• If you only plan to be in the home for a few years, then a hybrid ARM loan might be a good way to save money during those years. You see, during the initial fixed-rate period of a hybrid ARM, you can usually get a lower interest rate than you could get on a traditional fixed-rate loan. Of course, after the ARM adjusts the rate will go up. But if you sell the house before then, it won't matter.

Let me give you a good example from my own past. When I was near the end of my military career, the wife and I moved to Maryland for my last two-year tour of duty. We were pretty sure we weren't going to live there permanently, and would likely move after the two years were up. This knowledge helped us decide which mortgage option to choose.

Long story short, we got a hybrid ARM loan that had a low fixed rate for the first five years. Had we chosen a traditional fixed-rate mortgage instead, we would have paid more in interest. We sold the home after two and a half years ... long before the adjustment period. So we saved money without exposing ourselves to any extra risk.

So when trying to figure out which type of mortgage is right for you, you'll benefit from this kind of long-term thinking. Ask yourself how long you plan to stay in the home. If you plan to stay there for a long time, you have to consider the risks of an ARM loan. You don't fully know how the interest rate will adjust. If it goes up a lot, you might even find that you can no longer afford your monthly mortgage payment. This was a big contributing factor to the housing crisis we are now facing. So choose wisely!