Getting the Mortgage That's Best for You

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Knowing When to Refinance Your Mortgage

Although interest rates in the summer of 2004 were beginning to creep up, there still is opportunity to refinance your mortgage. Refinancing your mortgage is when you replace your current mortgage with one that has a lower rate. Lenders will tell you that it makes sense to refinance your current mortgage when rates have fallen 1.5 percent or more below what you are currently paying. If that applies to your mortgage and you plan to stay in your home for a period of time, you might want to think about refinancing.

Some lenders claim it makes sense to refinance when rates are less than 1 percent below your current rate, but, depending on closing costs, the length of time you are planning to stay in your home, and other factors, it's questionable. Ask the lending agent to run the numbers for you, considering these factors: the interest rate to be charged on the loan, closing costs, and how long you will be in the house. The numbers should tell you what is best for your situation.

Other Types of Mortgages

Remember we mentioned earlier in the chapter that fixed-rate and adjustable-rate mortgages aren't the only games in town? Here's a look at some of the other types of available mortgages:

• Hybrid mortgage  As the name implies, this type of mortgage is a mixture of fixed-rate and adjustable-rate models.
• Balloon mortgage  Another type of hybrid mortgage is a balloon mortgage. With this type of mortgage, you make payments with lower-than-normal interest rates for a while, and then you're expected to pay off the principal balance of the loan all at once! You normally have between 3 and 10 years before your lump-sum payment is due. This type of mortgage isn't a good idea unless you're absolutely sure you'll have money available to pay off the balance.
• Jumbo mortgage  This type of mortgage doesn't apply to the great majority of us. A jumbo mortgage, as the name implies, is one that exceeds the limits set by Fannie Mae and Freddie Mac. The 2004 limit was $333,700.

• Assumable mortgage  This is when the buyer of a home takes over the mortgage from the seller. It can be advantageous if the owner got the mortgage at a terrific interest rate, and the rates have increased significantly. Also, assumable mortgages rarely have the fees associated with standard mortgages.
• Seller financing  The seller of the home provides financing to the buyer, and the buyer pays back the seller instead of a mortgage lender.
• Biweekly mortgage  We'll get into more detail about this kind of mortgage in our next chapter, so for now we'll just tell you that the monthly payment is split into two, and you pay half of it every two weeks. This shortens the length of the loan dramatically. We'll tell you how in the next chapter.

As you can see, there's a lot to think about when choosing a type of mortgage. Try to get as much information as you can, and then make an intelligent, informed decision. But wait! There are other things to consider before choosing one.

Thirty-Year vs. Fifteen-Year Mortgages

Mortgages can be paid back over varying amounts of time, depending on the terms you agree on. The two most common payment periods are 30 years and 15 years. A 30-year mortgage has the advantage of lower monthly payments, because your loan is spread out over a longer period of time. However, you end up paying thousands of dollars more in interest on a longer-term mortgage.

With a 15-year mortgage, you have a higher payment each month, but you can usually get an interest rate that's one quarter to one half of a percent lower than on a 30-year mortgage. Paying off the loan at a lower interest rate and in half the time results in big savings, as the following chart shows:

As you can see, your interest savings are tremendous. Something to be considered, though, is how paying off a mortgage affects your taxes. The interest you pay on your mortgage is 100 percent tax-deductible, which reduces your after-tax cost. With a 30-year mortgage, more of your monthly payment is for interest, and you have a larger deduction than with a 15-year mortgage.

Some people choose 30-year mortgages even though they could afford the higher monthly payments of a 15-year mortgage, because they'd rather take the difference and invest it. They figure that in a good market, it pays off to invest rather than shorten the length of your loan and decrease your interest.

So what will it be? A 30-year fixed-rate mortgage? A 15-year adjustable? Before you decide, there's one more thing to consider: points.

Points

We've told you that points are fees (or actually prepaid interest) that amount to 1 percent of your loan. The tricky thing is that lenders charge different numbers of points on different mortgages. Usually, the lower the interest rate is, the more points you'll be charged and vice versa. If you want to lower your monthly payment, you probably will pay more points to do so.

Because points are prepaid interest, the more interest you pay initially means you pay less throughout the term of the mortgage via a lower interest rate. An example of this is a 6.7 percent mortgage with 3 points: If you don't want to pay the points, you can obtain a 7.45 percent mortgage, with no points. You pay the interest one way or the other. Which scenario is best for you depends on how much cash you have available to pay points. Ask your lender how the points affect your total loan interest payment, and then decide what is best for you.

You can either pay the points up front, at settlement, or you can finance them as part of your loan. For instance, if your mortgage is for $100,000, each point is worth $1,000. If your lender charges you 3 points, and you finance them, you'd have to increase your mortgage to $103,000—or, pay no points but pay a higher interest rate. Sound confusing? Just remember to compare the total interest to be repaid. This is the bottom line for you. When you choose a mortgage, you can usually lock in your interest rate by paying a commitment fee equal to 1 point at the time of application.