- The main cost of having a mortgage is the interest you have to pay the lender over the course of the repayment term. The type of loan you get affects how much interest you will pay. A loan with a shorter term results in paying less interest than a loan with a longer term. A loan with an adjustable interest rate can result in paying less interest in the short term than a loan with a fixed interest rate because the starting adjustable rate is usually lower than the fixed rate you would qualify for. However, the long-term interest on an adjustable-rate mortgage could be higher than on a fixed-rate mortgage.
- Homeowners generally choose between 15-year and 30-year mortgages. These two major types of loans each have both advantages and disadvantages. With a 15-year loan, you have the advantage of owning your home free and clear sooner than you would with a 30-year loan. However, the monthly payments on a 15-year loan are generally higher than the payments on a 30-year loan for the same amount. With a 30-year loan, you get the lower payments but it takes you longer to pay off your mortgage and in the later years ties up your income that you could have used for other purposes if you had opted for a shorter mortgage term.
- The type of loan you choose dictates how quickly you build equity in your home. Equity is the difference between the value of the home and the amount you still owe on the mortgage. In general, the shorter the term of your loan, the faster you will build equity. This is because the larger monthly payments on a short-term mortgage will go toward reducing the principal balance. Some special types of mortgages called interest-only mortgages and payment-option mortgages allow you to pay only the interest, or in some cases, even less, during the early years of your mortgage. This causes you to not build equity at all, or in the case of paying less than the interest, to build negative equity.
- The last major distinction among types of home loans affects whether or not your monthly payment amount will remain the same throughout the full duration of your mortgage. If you get a fixed-rate mortgage, your interest rate stays the same so your monthly payment also stays the same. This allows you to budget well in advance and have the peace of mind that your payment will not change. If you have an adjustable-rate mortgage, on the other hand, your monthly payment will change on a regular basis. You usually have a few years at the beginning of the mortgage with the same monthly payment, but the payment could increase or decrease every year after that, depending on the market interest rate. This leads to an unstable monthly payment that could get you in trouble if you can't afford it when it increases.
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