Before you lock yourself into 10 to 50 years of debt, there are a few things you need to know about home loans. They typically account for the largest single loan anyone will have in a lifetime, so it’s crucial that you do your research in advance to help you know a good deal from a bad one, know what your options are, and know what to expect from month to month.
Types of Loans
There are a few different ways for lenders to charge interest: fixed-rate, adjustable-rate, and interest-only. A fixed-rate mortgage is pretty straightforward: The terms you sign up for will not change for the duration of the loan. Adjustable-rate mortgages might initially present a lower introductory interest rate but, as the name implies, the rate is subject to change based on a predetermined index of national interest rates. As your rates change, so do your monthly payments. The Consumer Financial Protection Bureau recommends you calculate your payment based on your lender’s maximum rates (if available) to ensure you can afford the loan, even under extreme circumstances, before accepting it. Interest-only loans are unqualified mortgages that start out with fixed interest rates. The homeowner is not required to pay on the principal of the loan until the 10-year mark, which functions on the assumption that their income will increase over time to accommodate the larger payments.
‘Good’ Interest Rates
Although interest rates are subject to change from month to month, knowing what national average rates are doing can help you distinguish a good deal from a bad one. Since 2014, interest rates for mortgages have been steadily falling, reaching a low of about 3.4% in September 2016 before spiking up to 4.32% in December 2016, Bloomberg reports. These national averages are a great guideline for what you should expect, but your lender and credit rating will also be factors in determining your interest rate. Shop around and ask for estimated interest rate ranges before finalizing a loan.
If when you calculate your mortgage payment you discover that it’s less than your rent payment, that doesn’t necessarily mean that you’ll have extra money. In addition to the mortgage payment, as a homeowner you’ll need to save an additional 1% to 4% of the home’s value for inevitable home maintenance costs. You should also set aside extra money each month for annual property taxes and monthly insurance payments. If you have an escrow account, insurance and taxes are automatically added to each mortgage payment to ensure those bills are paid when they come due.
Mortgage insurance allows lenders to protect themselves in the event that their loan recipients aren’t able to make their mortgage payments. Generally, if you put down more than 20% of the home’s purchase price, you won’t be required to have PMI (private mortgage insurance). Although a smaller down payment would allow you to purchase a home you couldn’t otherwise afford, the PMI payments will increase your monthly payment, adding to the total amount paid for the home.
A Loan Doesn’t Have to Mean Forever
Home buying seems scary and intimidating: You’re suddenly irreversibly locked into that home in that city for the foreseeable future. But that’s not necessarily the case. You do have to invest some time in the home — selling for a profit in less than two years can subject you to a capital gains tax, and just think of the transaction fees piling up. To purchase a new home while you have an existing mortgage, you would need to contact your lender for the payoff amount, and then decide if you want to move first or sell first. (Your real estate agent is a great resource for navigating this situation.) Also keep in mind that you can qualify to refinance your loan later down the road if interest rates drastically drop, or if you’d like turn your adjustable-rate mortgage into a fixed-rate.
Sam Radbil is a contributing member of the marketing and communications team at ABODO, an online apartment search service. ABODO was founded in 2013 in Madison, Wisconsin. And in just three years, the company has grown to more than 30 employees, raised over $8M in outside funding and helps more than half a million renters find a new home each month.