What is the best type of loan for you?

The single most important factor in shopping for the best loan for you is knowing how long you plan on owning the property. Not knowing this would be like exchanging currency in a foreign country without knowing the exchange rate. If you don’t know how long you will own your home, there is no way of calculating the best loan rate for you. If you choose a fixed rate and are only in the home a short amount of time, you may pay too much in interest. If you pay points and only own for a short time, you will have thrown that money away up front! (See example below.) Conversely, if you choose an adjustable rate, or decide not to pay points to lower your rate--and own the home for a long time, you might pay too much in interest.

A personal story from Joel McDonald:

I learned the above lesson the hard way when I bought my first house in college. I knew I would only own the house 3 years because I didn’t think I would stay in the area after graduation. However, I only considered going with a 30-year fixed-rate loan because that was considered the "least risky". In hindsight, I was kicking myself when I sold the home because my "low risk" fixed rate stayed the same, while adjustable rates went down! My fixed-rate payment (9.5% at the time) was $849 (principal & interest). Had I gone with an adjustable interest rate, my payments would have been $741 in that first year, and would have gone down to about $655 when I sold the property! (Adjustable rates at the time I bought my home were at 8%, and had gone down to below 7% at the time I sold it!) In the course of the three years I owned the home, I could have saved nearly $5,000 by going with an adjustable interest rate instead of fixed!

Hindsight is 20/20 and the above example is the epitome of that. However I did learn that I should have analyzed all of my options before deciding what was best for me. Let’s analyze this pretending I didn’t know what rates would do in the next three years:

My lender told me at the time I was shopping rates, that adjustable rates were not allowed to go up more than 1% per year no matter how high market interest rates went. I didn’t even need a financial calculator to figure out that even in the worst case I would end up paying about the same amount over the 36 months I owned the home if I chose to go with an adjustable interest rate. Instead of paying $849 for 36 months ($30,564), I would have paid $8892 (8%) in the first year, $9744 (9%) in the second year, and $10,632 (10%) in the third year (for a total of $29,268 over 36 months). Even in the worst case scenario, I knew it was not possible for rates to be above 10% at the end of three years—meaning I couldn’t have gone wrong! To add insult to injury, rates went DOWN by about 1.25%

Nevertheless, I hope the above example of my poor judgment will help you better analyze what the best option for you is. Remember--before even thinking about fixed, vs. adjustable, vs. any other option, have a good idea of how long you plan on owning the home.

Please also keep in mind, you don’t have to kill yourself trying to figure these answers out for yourself! I am glad to discuss any concerns you may have, as are all of the lenders I know of (and I know of a lot of very competent lenders).

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