Choosing the best mortgage now
 
With rates on the rise, picking the right one is all the more important.
April 22, 2004: 3:58 PM EDT
By Jeanne Sahadi, CNN/Money Senior Writer
 

NEW YORK (CNN/Money) – Mortgage rates have been on the rise for the past month, but they're still at fairly low levels historically speaking.

If you're in the market for a new home, you figure it must be less expensive to buy now than when rates go up even further, assuming housing prices stay strong in the near term, something economists expect will happen. That may be the only thing you can be sure about.

But finding the best type of mortgage for your situation can feel a little like finding the perfect ecru in a sea of beige.

It doesn't have to be that way. If you ask yourself the right questions, you at least can narrow your search to the best category of mortgage for which you need to comparison shop.

15-year versus 30-year debate
The first question you should ask is, "How much can I afford to pay on a monthly basis?"

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Keep in mind, your mortgage payment is only part of what you'll pay to live in your home. You also should budget for furniture, your house's upkeep and the general expenses of life (like, say, food).

A 30-year mortgage will have a lower monthly payment and a higher interest rate than a 15-year mortgage. So you'll have a smaller monthly obligation but you'll pay more for your house over time because you're paying it off with interest for a longer period.

Conversely, a 15-year mortgage will have a higher monthly payment and a lower interest rate so you'll pay less for your house because you're paying it off in a shorter period.

"For most home buyers, especially first-time buyers, taking a 15-year (or 20-year) mortgage is out of the question," said Keith Gumbinger, vice president for mortgage tracker HSH Associates. The higher monthly payments are often too much to handle for these types of buyers.

But for home buyers with sufficient income and a desire to be mortgage-free in a short time, a 15-year loan might be a good bet.

Fixed versus adjustable-rate conundrum
The second question you should ask is, "How long will you be in the house?" You probably can't answer with absolute certainty, but you can play the odds.

Say, for example, you're single and buying a small condo but you can easily envision yourself married; or you've just started a family and plan to expand it at some point. Chances are good you'll want to trade up to a new home in five to seven years. On the other hand, maybe you've had your family and want to settle into a place with a good school system, which your kids will be using for the next 12 years.

Whatever the answer, it will help you decide whether it makes sense to get a fixed-rate or an adjustable-rate mortgage (ARM).

A fixed-rate mortgage locks in a rate for the length of your loan.

ARMs, meanwhile, are short-term fixed-rate loans: After the fixed rate term is up, the rate adjusts at regular intervals in accordance with current interest rate conditions at that time. A 5/1 ARM, for example, has a fixed rate for five years and then adjusts every year for the next 25 years. (ARMs typically run on a 30-year schedule.)

The length of the fixed-rate term on an ARM typically can range anywhere from one month to 10 years. The longer the rate is fixed, the higher the interest rate you'll get. But generally speaking -- and there have been exceptions in the past -- ARMs will cost you less in the short-term. With the ARM, both your monthly payments and interest rates should be lower than either a fixed rate 15-year or 30-year mortgage.

The risk with an ARM is that when interest rates rise, you could end up paying much more than you bargained for. "You're subject to the vagaries of the market," Gumbinger said. That's why in today's low-rate environment, he noted, "You want to maximize the fixed-rate picture to match your time frame."

If you know you'll be in a home for 12 years or more, a 30-year fixed rate mortgage might work better for you than, say, a 5/1 ARM, where you fix a rate for five years and then it adjusts every year after that. But if you think you won't be in the home longer than five or six years, a 5/1 ARM might make more sense.

A dollars-and-sense exercise
Say you need a $200,000 loan to buy a home and you can get the current average rates for a 30-year fixed, a 15-year fixed, or a 5/1 adjustable rate mortgage.

With the 30-year fixed rate at 6.62 percent, your monthly payment would be $1,280. The interest you pay over the life of your loan would total $260,786.

With a 15-year fixed rate at 5.94 percent, your monthly payment would be $1,681. The interest you pay over the life of your loan would total $102,623, or about $158,163 less than the 30-year fixed.

With a 5/1 ARM at 4.20 percent, your monthly payment would be $978 for the first five years. The total interest you pay over the life of the loan if you stayed in your home past five years is anyone's guess because your rate would then adjust annually. But if you move after five years, that won't be an issue.