The most common type of mortgage granted is the 30 year fixed rate mortgage (Choosing the right Mortgage – Freddie Mac). However, some home buyers may consider this option too expensive for their situation and may choose an alternative option.
Some alternatives include:
- A 15 year fixed rate mortgage is often considered the next best option to 30 year fixed rate mortgages. The monthly payments are higher, but equity builds faster, the loan is paid off sooner, and they commonly include an interest rate that’s 1 to 1.5 percent lower than a comparable 30 year fixed rate mortgage. On these terms, the total costs over the entire life of the loan are less expensive than those with longer terms. This choice is a common choice for borrowers who intend to stay in the home a long time.
- A 20 year fixed rate mortgage is a compromise between the 15- and 30-year options. The monthly payments may be slighter higher than the 30-year loan, but more manageable than a 15-year loan. Some lenders may be able to customize terms for a different number of years between the benchmark 15-, 20-, or 30-year loans.
- 5/1 ARM (Adjustable-Rate Mortgage). These loans include a low fixed rate for 5 years followed by annual adjustments at fully-indexed current rates for the remaining 25 years. ARMs may have lower payments initially, and are often chosen by those who don’t intend on staying in a home for a long time.
- For buyers wanting lower monthly payments than a 30 year fixed rate mortgage, some lenders offer 50 year mortgages. Many lenders are wary of recommending such a long-term loan because the advantages are very slight. Unless the property is occupied for decades, equity builds so slowly that experts sometimes equate this option as being no better than renting. There may be little profit in selling the property and the total cost, including interest, over the life of the entire loan is exorbitant.
- Paying in cash is another option. Investors are more likely to use this option than most home buyers who usually do not have this amount at their disposal. Anyone who can pay all, or a large part, of the total price in advance, enjoys the benefit of having a much lower loan amount to finance. For those who choose this option over financing a traditional 30 year fixed rate loan, for example, it would be prudent to ensure they still preserve some cash for taxes, insurance, home improvements, and emergencies.
When comparing 30 year fixed rate mortgages with alternatives, the word “expensive” can have different meanings. Home buyers should first define what “expensive” means to them, whether it means a high monthly payment, high interest rate, substantial closing costs or down payment, or a paying more in total costs over the entire length of the loan. Most importantly, home buyers should do their research and ensure they understand all the details about the mortgage options available to them.