Purchasing a home is a major milestone. Whether it’s your first – a quaint fixer-upper – or a “for the rest of your life” dream house, a mortgage allows you the comfort and security of your very own home. But it’s quite likely you’ll have several mortgages through the years, each suited to your particular stage of life.
Your first mortgage
To buy your first home, you may need the low monthly payments that an adjustable-rate mortgage (ARM) can provide. When you’re just starting out, you’ll be happy to learn that ARMs are easier to qualify for than a traditional fixed-rate mortgage. And because most of these loans start with an interest rate that doesn’t change for a specified period of time, such as five years, it can be perfect for younger buyers who don’t intend to stay in a particular home forever.
After that initial period, the interest rate may change periodically, usually annually. If market rates rise, your monthly payment goes up. If rates fall, your payment probably will decline, too – though not all ARMs adjust to lower rates.
For example, a “5/1” ARM means your interest rate – and your monthly mortgage payment – stays the same for the first five years and then is reset each year. As you pay down the loan, any rate adjustment applies to the remaining principal balance. If you think an ARM is right for you, make sure your budget has a bit of breathing room, just in case interest rates rise and your income doesn’t keep up – so you’ll be able to cover a higher monthly payment.
Caps are common
Adjustable-rate mortgages often limit interest-rate adjustments with “caps.” These maximums may apply to just the first periodic change or to each subsequent rate review. Sometimes a cap can stipulate the maximum interest rate allowed on the loan over its entire term.
Some ARMs offer payment caps, as well. That’s a limit to just how much your monthly obligation can increase during the life of the loan. They can seem very appealing but there’s a potential downside. If your payment doesn’t cover all of the interest due, the remainder can be added to the principal balance of the loan, effectively meaning that you are compounding interest on – and increasing – your debt. In the most extreme circumstances, at the end of the loan term you may actually owe more than you borrowed! When applying for a loan, ask about all available caps and be sure you understand what each one means.
Other mortgage milestones
Later, as your family grows – or you settle into a career and want to put down roots – you’ll likely consider buying a home with a fixed-rate mortgage, or one where your monthly payments don’t fluctuate. You may choose a 15-, 20- or 30- year loan, knowing your interest rate will never change.
Once you’ve settled in to your dream home, you may think you’re done with mortgages. But there are circumstances that can warrant another visit to your lender. If interest rates fall from the level you locked-in with your traditional fixed-rate mortgage, you may want to refinance to lower your monthly payments. It’s often said that a 2% drop in rates can make a loan refinance worthwhile but the real rate trigger will depend on your particular circumstances. It’s a good question to ask your mortgage lender.
Another reason to revisit your home loan situation is for a home equity loan or line of credit. Tapping the current market value of your home for extra cash can be an excellent way to pay for home additions, repairs or remodeling – or any other big project or purchase you have in mind. The interest you pay on these debts can also reduce your tax bill under the right circumstances. Talk to a tax adviser about your specific situation.
And finally, as you enter retirement, a reverse mortgage may play a significant role in boosting your life-after-work income. If you’re 62 years of age or older, you can stay in your home while converting a portion of its equity into cash – and make no monthly payments.
As you can see, mortgages can play a large role in your home life and lifestyle through the years – from buying your first home, to growing a family and enriching your retirement.
Hal Bundrick, NerdWallet