Choosing the Best Loan for You

This vital step of obtaining a mortgage is one of the most important steps you will take before, during, and after the process. This is the step that may determine your financial stability and situation in the future--choosing the wrong mortgage program for your needs may harm your pocketbook more than you think, how much you ask?

(This is a fictional example) Imagine the current situation many borrowers in the Bay Area see themselves in today. They obtained one of those Nightmare Mortgages or as you may recognize it, an Option-ARM. At the time the idea made sense. The borrowers planned on buying their $400,000 house with a 10% down payment. They are barely making the minimum payment. A year passes. The borrowers have been making minimum monthly payments on time, every month, but realize they can no longer afford the payments that are constantly creeping up with each passing month. Their balance is now $381,400--$21,400 of the down payment they put into the house has been eaten up. The real estate market has since changed. There is a huge supply of homes on the market, interest rates have adjusted, there are economic woes--as a result, it is more difficult to sell their home and their home's value has dropped. Thankfully their home's value hasn't dropped that much, but the value is now $390,000. Now they have to refinance since they can't sell the house. Unfortunately the Option-ARM is no longer a choice for them because not only do they not have equity in the house, they cannot afford the higher payments. All other refinance options are too costly. What are they going to do?

This is where taking the time to analyze and determine which mortgage program was best to begin with would've saved this family the trouble of having to make difficult decisions now. Thankfully you've already considered the worst options and know that taking the extra time to decide on the right loan would be beneficial to you and your family. So now is the perfect time to start thinking about the questions that will lead you in the right direction. Keep in mind the following suggestions for mortgage programs do not include the other options that you have such as interest only payments.

1. How long do you plan on staying at this property?
This is an important question to ask yourself. Many people will say that they intend on living at their house for less than three or five years before moving onto another home, but they underestimate how quickly time flies by. So really sit down and think about the reality of the situation--how long you think it will take to adjust to paying this mortgage. How long do you think it'll take after adjustment to be able to expand your financial horizons in order to increase your mortgage possibilities in the future? When will you be ready to move up to a larger house with a larger monthly payment?

If you plan on staying at your house for...
1-3 years - 3, 5 year ARMs
4-5 years - 5, 7 year ARMs
7-10 years - 7, 10 year ARMs or 15, 20 year fixed rates
Forever? - 15, 20, 30, 40, 50 year fixed rates

2. Do you intend on keeping this property after you move on to another home? Or will you sell it?
When property owners move onto another home and keep the property they already own, some refinance the mortgage to make the monthly payments more affordable and suitable to the property being an investment. However, you may want to think ahead and skip that step by financing the property as an investment to begin with if you are sure that you will keep the property and if it makes financial sense to obtain a mortgage such as this. How long will you be keeping the property as an investment? Indefinitely?

For refinancing your investment, if you plan on keeping this property as an investment for...
1-3 years - 3, 5 year ARMs
4-5 years - 5, 7 year ARMs
7-10 years - 7, 10 year ARMs or 15, 20 year fixed rates
Forever? - 15, 20, 30, 40, 50 year fixed rates

3. Would you rather have a lower payment or would you rather build your equity faster?
This is a tradeoff question. If you prefer to have lower monthly payments then it's going to be difficult to build the equity in your property. However, if you don't mind higher monthly payments, then you will see the equity in your property build faster. Another way of minimized your monthly payments is by obtaining an interest only mortgage where you are only required to pay the interest due on your loan every month rather than paying both interest and principal. Another way to increase the rate at which your equity builds is by making biweekly mortgage payments or pay a little more at the end of each month. Remember, in order to build your equity faster, the shorter the life of your life the faster your pay it off resulting in faster equity build up over the years.

If you want to...
Minimize your monthly payment - 1, 2, 3, 5, 7 year ARMs with interest only options
Build your equity - 15, 20, 30 year fixed rates

4. How well do you tolerate risk?
Obtaining any mortgage that is not the traditional 15 or 30 year fixed rate involves a certain amount of risk. If you know you can tolerate a higher level of risk and you do not mind the possibility of rate fluctuations, real estate bursts, or market shifts, then you can well tolerate the risks of adjustable rate mortgages (ARMs), Option-ARMs, or Hybrid Option-ARMs. However, if you need to know that your mortgage is stable, then it is better to go with a fixed rate. These types of programs will provide you with the stability and peace of mind that you may need.

If you feel...
Uncomfortable with instability - 15, 20, 30, 40, 50 year fixed rates
Comfortable with instability - 1-3, 5, 7, 10 year ARMs, Option-ARMs

5. This is a silly question, but you may want to ask it of yourself: Where do you think rates will go?
If you think interest rates can only go up, then you may want to obtain a longer term fixed rate. If you think interest rates are going to drop, then you may want to obtain a shorter term fixed rate and take advantage of the lower interest rate in the mean time until you can refinance with an even lower interest rate. This decision ties into your level of risk-tolerance as well.

If you think rates are going to...
Rise - 15, 20, 30, 40, 50 year fixed rates, Hybrid Option-ARMs
Drop - 3, 5, 7, 10 year ARMs, Option-ARMs

If you want to learn more about the actual mortgage programs mentioned above, read our article: "All Types of Loan Programs," which gives a more detailed explanation of the programs, its advantages, and disadvantages.