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Choosing the right mortgage

When it comes to mortgages, the length of the agreement and the sum of money involved make it vital that you do your homework. More so than almost any other financial transaction, it pays to get the details right on your mortgage. Your home may be the biggest purchase of your life, and the type of mortgage you choose significantly influences how long and how much you pay for it.

There are many factors to consider when shopping for a mortgage, but mortgage rates fall into one of two categories: fixed rate and adjustable rate. Knowing the difference between the two is key, as which you choose can make a big difference to your bottom line.

Fixed-rate mortgages

Fixed-rate mortgages are the most common type of mortgage loan. They use a static interest rate that locks in an unchanging monthly payment for the life of the mortgage. Fixed-rate loans most often come in 15-, 20- or 30-year terms.

  • Short-term fixed loans, such as 15-year loans, typically have lower interest rates than 30-year loans, but higher payments, as the amount is spread out over fewer years.
  • Long-term fixed loans, such as 30-year mortgages, have lower monthly payments, yet tend to have higher interest rates, and you will pay more interest over time.
  • Because they're not susceptible to market forces, fixed-rate mortgages guard you against payment increases from interest rate spikes.
  • If interest rates decline, your mortgage payment won't go down. But you can consider refinancing if rates drop low enough to offset the transaction costs.

Adjustable-rate mortgages (ARMs)

Adjustable-rate mortgages feature interest rates that fluctuate according to market conditions throughout the life of the loan. You may start with a lower monthly interest rate than the prevailing fixed interest rate, but you will likely end up with a higher rate after the initial loan adjustment period, which can last from 6 months to 10 years.

  • ARM interest rates typically move up within three, five or seven years, and even if interest rates don't increase, your payment may still rise.
  • When interest rates drop, your payment may not lower much, if at all.
  • Early payoff penalties exist on some ARMs, making it impossible to avoid higher payments due to interest rate increases.
  • After the interest adjusts initially, it may continue to change throughout the life of the loan.

Fees and closing costs

Other factors to consider when choosing a mortgage are the fees and closing costs. These can vary between lenders, so it pays to examine how these charges will affect your mortgage's overall price.

Typical fees include appraisal and application fees, origination/underwriting fees, broker fees and settlement/closing costs. The variety of fees can seem dizzying (and costly) to borrowers, but they are often negotiable. No-cost loans also exist, but they usually feature higher interest rates.

Buying a home can be a complex and tiring process. But by thoroughly examining your options, you can better your chances of finding the home loan that best suits your long-term needs.

Choosing the right mortgage

By Julie Bawden-Davis | Money Rates Columnist

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