Real Estate NewsMortgage Options: How Much Of A Gambler Are You?
When it comes to choosing a mortgage, your gambling instincts (or lack thereof) may surface. Will you throw caution to the wind with a one-year adjustable-rate mortgage (ARM) or play it safe with a set monthly payment over thirty years? Will you go for more points and less interest, or lower interest but higher costs up-front? No matter what tack you take, there"s risk and reward, pro and con, factored into each mortgage choice..
Safe, Yet Costly:
The Johnsons have a moderate income and three young children so they want to play it safe by keeping their monthly payments low with a 30-year fixed-rate loan. They"re also growing their savings, so putting only 5 percent down seemed the right approach.
But safety comes at a price. Because of their low down payment, they"re forced to pay private mortgage insurance (PMI) until they have approximately 20 percent equity in the home. This equates to thousands of dollars of additional expense over the life of the loan which is, unfortunately, not tax deductible. The Johnsons might improve their position by refinancing when they have more equity to get a lower the interest rate and remove the requirement for PMI.
Risky, Yet Cost Effective
Sam and Monica Chan are financially savvy baby boomers who have a high-risk threshold and want to save money on their mortgage whenever possible. That"s why they"ve chosen a one-year adjustable rate mortgage (ARM) to take advantage of interest rate dips and new loan programs as they occur.
They recently realized a savings windfall by refinancing into an ARM with zero closing costs, zero points, and somewhat higher rates. By taking risks with adjustable rate mortgages, the Chans believe they can ride the lowest interest rates available and have the 30-year loan paid off at least ten years early. The risk the Chans" take, of course, is the threat of inflation and corresponding higher interest rates for ARMs.
Moderate Risk, Moderate Gain
The Connicks" focus is to have their home paid off by the time they both retire in 15 years. That"s why their mortgage of choice is a 15-year fixed-rate loan. Going with the shorter amortization period means less interest to pay and faster equity build-up. And since they want to sidestep the additional cost of private mortgage insurance, they made a 20-percent down payment using some of the cash from their retirement savings.
The risk to the Connicks is that circumstances could change to negatively impact their plans. For example, should one of the spouses lose his or her job, the higher payment on the 15-year loan could become a stretch for their income. Additionally, using cash from their retirement account for part of the down payment will lessen the account"s build up potential, leaving them short of required funds when they"re ready to retire. To offset risks, the Connicks might want to choose a 30-year amortization and make scheduled prepayments to the principal if there"s any sign that either of their jobs is unstable or if either would not want to work the remaining 15 years.
As the examples show, each type of mortgage has its own inherent risks and rewards. The real gamble is deciding which mortgage you"re comfortable with based on your financial picture and risk-tolerance level. No matter how much you stand to save financially, don"t choose a loan if there"s any chance it might interrupt a sound nights sleep!
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