Which mortgage is best?

It’s a great time to shop for a mortgage. Mortgage money is plentiful. Lenders are anxious to lend. And interest rates are at a multi-decade low.

Thirty-year fixed rate mortgages in the 6 percent range are popular with today’s borrowers. So are15-year mortgages at less than 6 percent. Five-year fixed/AMR loans for only 5.5 percent are hard to refuse. Or should you go with an ARM (adjustable rate mortgage) with a start rate of 3.95 percent?

With so many mortgage alternatives available, how do you decide which one is right for you? Here are a few guidelines to help you decide:

If you are buying or own a home you plan to live in indefinitely, a 30-year or a 15-year fixed rate mortgage are the most attractive options. With both options, the monthly mortgage payments are fixed for the life of the loan, which gives you payment security.

The monthly payments on a 15-year loan are higher than they are on a 30-year, so you need more income to qualify. But if you can qualify, you’ll own your home free and clear of a mortgage in just 15 years. And the interest savings is huge.

The interest rate on a 15-year mortgage is about 1/2 percent lower than it is on a 30-year loan, plus you pay less interest over time—about $100,000 less on a $200,000 mortgage. A disadvantage to some borrowers is that you lose a tax deduction when your mortgage is paid off.

One advantage of a 30-year mortgage is lower monthly payments, which makes qualifying easier. A 30-year mortgage also offers more flexibility, particularly if you take out a mortgage that charges no penalty fees for early prepayment. Let’s say that your income is sporadic. When you receive a bonus, you can pay down the principal balance to reduce your interest expense. But when cash is in short supply, you can stick with the manageable 30-year amortized payment. With a 15-year loan, you’re stuck with the higher payment regardless of your cash flow situation.

HOUSE HUNTING TIP: Even though low interest rates make fixed-rate financing the most popular choice, ARMs may be preferable for some borrowers. If you’re sure you’ll be moving again within five years, you’ll probably save money with an ARM that is fixed for five years at a lower interest rate than either a 30- or 15-year fixed loan. After five years, the mortgage converts to an adjustable.

ARMs with interest rates that adjust from the get-go aren’t too popular with most borrowers today because interest rates are expected to rise when the economy gathers steam. But if you are trying to keep your monthly payments as low as possible, this could be the right choice for you.

Let’s say you bought your home a year ago when you and your partner both had good incomes. One of you lost a job and you’re trying to survive on one income. Refinancing a higher interest rate fixed mortgage into an ARM that offers several payment options could be the answer to your short-term cash flow situation.

ARMs that allow negative amortization also offer the borrower several payment options. Negative amortization occurs when the payment doesn’t cover the interest owed. When this happens, the unpaid interest is added to the principal and your loan balance rises.

You can avoid negative amortization by making the fully amortized payment or the interest-only payment amount. But if you’re short on cash, you can make the minimum payment due.

THE CLOSING: Before you sign up for an ARM with negative amortization, make sure you understand how the loan works, and be diligent about paying any deferred interest as soon as you are able.

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