Save Big Bucks by Studying Types of Mortgages

You are probably willing to walk away from your dream house because its price is $5,000 or $10,000 too steep. After all, savvy consumers know that paying too much is the best way to turn a good investment into a bad one.

But are you equally careful about the type of loan you secure to buy the property? If you aren’t, you ought to be.

Over time, the interest paid on that loan will probably triple the cost of your original investment. In other words, if you borrow $150,000 at 9.75%, over 30 years you will have paid more than $463,000 for your house and its financing.

Each tenth of a percentage point--the difference between 9.5% and 9.6%--will cost you hundreds of dollars. And, in some extreme cases, picking the wrong kind of mortgage can even put your property at risk.

With today’s dizzying array of choices, picking the right mortgage is not easy. Do you want a fixed rate or an adjustable one? Do you want a 30-year mortgage or one with a 15- or 20-year term? Some institutions even offer 40-year mortgages for those looking for lower monthly payments. Can you handle a mortgage with a balloon payment? Are you interested in a hybrid, such as a loan that starts with a fixed interest rate but reverts to an adjustable rate after a few years?

To choose a loan, home buyers need to do some soul searching. Consider how long you realistically expect to live in the home you’ve chosen and weigh the likelihood of being transferred or otherwise forced to move earlier.

Then take a look at your income. Is it steady? Do you receive relatively predictable raises each year? Is there a possibility that you or your spouse will opt out of the work force soon to raise a family or to pursue some other personal goal?

The answers to all these questions are pivotal to which kind of loan will be best for you and your family.

Those who expect to be in a home for a long time and have a steady, but not rapidly rising, income might prefer a fixed-rate mortgage.

The advantages of these loans are clear: No matter what happens to interest rates during the next 30 years, your rate and payments are locked in--and that’s a comfortable spot to be in when rates are rising. If rates drop significantly, you can refinance.

The disadvantage is also simple: You usually pay more for a fixed rate. Where adjustable loans can start in the 7.5% range these days, fixed loans cost 9.5% to 10.5%. Sometimes banks charge higher up-front fees, often called “points,” on fixed-rate mortgages too.

If you plan to be in a house for only a few years, the extra expense is probably not worth the benefits. But you might want to consider a mortgage that starts at a fixed rate and automatically converts to an adjustable mortgage after a set period, such as five or seven years.

If you are positive that you will move within a set period, you might also look at loans that have balloon payments. These loans are often provided by developers or banks that offer low-rate financing to sell houses in a development. The catch for the buyer is that these loans must be paid off or refinanced before the balloon payment is due. And that’s risky.

Why? It is possible that the real estate market will sour or you’ll have a personal reversal that makes it difficult or impossible to refinance that loan. At that point, your choices are to sell the house or allow the lender to foreclose. Neither option is particularly attractive.

Some people will find that their best choice is an adjustable loan. These loans often provide low initial rates, less expensive up-front fees, and both annual and life-time interest rate “caps.” The lower initial costs make it easier for consumers to qualify. And, if you plan to stay in the house for only a short while, they can also save you money.

However, there are literally hundreds of variations to the basic adjustable-rate mortgage. To choose one, you need to look at the initial rate, the index to which your loan is tied, the frequency of rate adjustments, whether there are interest rate or payment caps and up-front fees.

Analyzing all the options is time-consuming, but considering how much you’re spending, it’s probably worth it.