With mortgage interest rates low, home values rising, and lenders more friendly to borrowers than they’ve been awhile, now might be a good time to get a new mortgage, or refinance the one you already have.
Although your situation may differ, most of the time there are a few simple rules to use in deciding what loan terms are the most favorable to you.
1. Get a fixed rate loan
Sometimes your only option provided by the lender is an adjustable-rate mortgage, in which case you should get the rate fixed for as long as you can, and plan on higher monthly payments once the rate can fluctuate.
But if you can get a fixed rate option, you should take it. Especially now, since fixed rate loans are about the same rate as most adjustable-rate options.
Not only will the certainty and predictability of the fixed rate payment provide some comfort to you, but it can work to your advantage in an inflationary environment.
2. Go for thirty years
Yes, a shorter loan (such as a 15-year mortgage) often has a slightly lower interest rate than the 30-year option. But there are several reasons it may be safer and smarter to take the longer loan.
First, the monthly payment is lower. Say you’re borrowing $160,000 and your choices are a 30-year loan at 4% interest, and a 15-year mortgage at 3.5%.
The payment on the 30-year loan would be $763 per month, compared to $1,143 per month for the 15-year option.
The lower payment on the 30-year loan may help you qualify for a loan you wouldn’t get with higher monthly payment associated with a shorter loan.
The savings can be used to cover other spending needs, or can be used to save more for retirement or higher education expenses.
Even if you take out the 30-year loan mentioned above but make the payment that would have been required with the 15 year option ($1,143), you will still pay the mortgage off in about 15 years and 9 months.
But in the meantime, if you want or need to lower your payments back down to the minimum required amount ($763), you will retain that option.
3. How much down?
Your lender and your circumstances will generally dictate how much can (and need to) put down as a down payment. Or, if you’re refinancing, how large your loan can be (as a percentage of the home’s appraised value).
As a rule of thumb, it’s best to get a loan for 80% of the home’s appraised value. That means if your place is worth $200,000, your ideal loan amount would be for $160,000.
A loan for a larger percentage than 80% means you may have to pay “private mortgage insurance”, or “PMI”. Not only will this cost you more money every month, but it may affect your ability to qualify for the loan.
And unless your home’s value appreciates quickly after you get the mortgage, or you can come with a significant amount of money to lower the “loan to value” ratio, it can be difficult to get the PMI requirement removed.
Even if you have enough money to make a down payment larger than 20% of the home’s value, you may want to instead preserve what you can for moving expenses, home improvements, or future cash crunches. If you’re refinancing an existing mortgage, it might be a good idea to get a “cash out” of the difference between the balance of your current mortgage, and 80% of your home’s value. You can use the extra money for upcoming expenses that might force you to borrow at less-favorable terms than what is offered by the mortgage, such as a car purchase, home remodeling, or higher education expenses.