On the other hand, if you know you will be selling in the not-too-distant future, the lower interest rate that comes with an ARM might make sense. Even if rates jump in a few years, you’ll be selling anyway so it won’t impact you. You can also select a hybrid ARM that is fixed for a certain number of years (3, 5, 7 or 10) then adjusts annually for the remainder of the loan. The risk with an ARM is that if you don’t sell, your payments may go up and you may not be able to refinance.
Your credit score can make a big difference in how much home you can afford and how much interest you'll end up paying. For example, if you're obtaining a $200,000 mortgage and have a FICO score of 750, you can expect to pay $138,324 in interest over the term of a 30-year mortgage as of this writing. On the other hand, with a score of 650, you can expect to pay almost $35,000 more. MyFICO.com has an excellent calculator that can tell you the cost of your credit score. Before you start the homebuying process, it can be a good idea to check your credit report and FICO score and to do damage control if necessary.
Example – A $200,000 five-to-one-year adjustable-rate mortgage for 30 years (360 monthly payments) starts with an annual interest rate of 4% for five years, and then the rate is allowed to change by .25% every year. This ARM has an interest cap of 12%. Payment amount for months one through 60 is $955 each. Payment for 61 through 72 is $980. Payment for 73 through 84 is $1,005. (Taxes, insurance and escrow are additional and not included in these figures.) You can calculate your costs online for an ARM.
Many real estate agents want you to be pre-qualified for a loan before they will start to work with you. The mortgage pre-qualification process is fairly simple, usually just requiring some financial information such as your income and the amount of savings and investments you have. Once you are pre-qualified, you will have a better sense of how much you can borrow and the price range of the homes you can afford.
If you can afford the higher payments, or are willing to buy a less expensive home, a 15-year mortgage can save you thousands of dollars in interest and can allow you to own your home free and clear in half the time. Fifteen-year interest rates are about one percentage point lower than 30-year rates, and you might be surprised how much the combination of a lower rate and shorter amortization period can save you.
Hybrid Adjustable Rate Mortgages (ARMs): Mortgages that have fixed payments for a few years, and then turn into adjustable loans. Some are called 2/28 or 3/27 hybrid ARMs: the first number refers to the years the loan has a fixed rate and the second number refers to the years the loan has an adjustable rate. Others are 5/1 or 3/1 hybrid ARMs: the first number refers to the years the loan has a fixed rate, and the second number refers to how often the rate changes. In a 3/1 hybrid ARM, for example, the interest rate is fixed for three years, then adjusts every year thereafter.