First let me preface this article with the fact that you should always enlist the assistance of your local Houston mortgage professional to help you fully understand all of the loan options that are not only available to you but actually make the most sense relative to your goals. It's very common for an individual client to assume a fixed rate mortgage is best when in fact there are many more options that could end up saving you hundreds or even thousands more. With that said, I'm going to focus on the three most common options to choose from or Fixed Rate, Adjustable Rate (ARM) or Interest Only loans.
First let's start with Fixed or Adjustable rate loans. We will assume in this example that the loans are based on 30 year terms. Both of these loans are fully ammortorized over a 30 year term which means that the monthly payment includes both principle and interest on the loan. The most important difference between these two loans is that one is adjustable and the other is fixed. The beginning interest rate (also known as the Start Rate) on the ARM is often much lower than the rate on the fixed rate loan.
The single best question to ask yourself when choosing between these two options is; how long do you intend to stay in this home? Surprisingly, clients often fail to fully vet this question because you need to consider a lot of different variables such as employment terms, whether you intend to move out of state or be reassigned to a different territory in the near future, whether you plan on increasing the size of your family, whether you consider your purchase a starter home etc .. As a Mortgage Banker I never recommend an ARM term of less than two (2) years and usually not more than five (5) years. More specifically, these terms represent the portion of time for which the interest rate and payment on the ARM is actually fixed and cannot change. Let's take a $ 250K purchase and compare the interest rates and payments on a three (3) year ARM versus a fixed rate. Using current pricing available to me today the rate on the three year ARM is 3.125% and the rate on the fixed rate is 5.125%. In comparison the payments are $ 1,071 for the ARM and $ 1,361 for the fixed rate. The savings differential is $ 1,361 less $ 1,071 multiplied by 36 (the length of time the ARM is fixed) or $ 10,440 in favor of the ARM over the first three years. Simply put, not fully understanding the length of time you intend to stay in your home can cost or save you thousands depending on the outcome.
Interest only loans are not much different in theory than an ARM. There is a period of time for which the interest only period is fixed (ie. 3,5,7 or 10 years) except for the fact that the payment on the interest only is exactly as it sounds, it's the interest. Generally this type of loan is more difficult to qualify for and involves a more multifaceted thought process on the part of the client. These types of loans are great for large purchases and or clients who have up and down income because they allow you to pay only the interest when needed with the benefit of anything more than the interest being paid resulting in a direct reduction (dollar for dollar) to the principle. To better understand the benefits of this type of loan I recommend that you consult with your local mortgage professional.