The 30-year fixed ratemortgagehas stood as the gold standard for American home buyers since1954, whenthe Federal Housing Administration broadly adopted it. Sowhy is this the go-to mortgage for most people?
What is a 30-year fixed rate mortgage anyway?
It boils down to affordability and predictability. With this kind of loan,payments are made over a longer period of time (as opposed to a 15-year fixed-rate mortgage), so your monthly bill will be lower. Plus, the principaland interestyou need topay each month are fixed, which means you’ll never get sticker shock when you open your bill.
But for prospective home buyers in today’s market,it’s important to understand that a 30-year fixed-rate mortgage is not always the best option.
“There’s no one-size-fits-all mortgage,” says Tim Dineen, a mortgage specialist at New Penn Financial, in Northern Virginia.
Many factors come into play when determining what type of loan is right for you, including your credit score, income, down payment amount, and, of course, what size loan you need.
So what are the factors that lead you to decide that a 30-year fixed-rate mortgage might not bethe loan for you?
Sign No. 1: You plan on moving again in a year
The whole point of a 30-year fixed-rate mortgage is to spread out your payments overthe long haul, so if you might movein a few years, what’s the point?
There are exceptions, but three years is a commonrule of thumb for how long you need to own a home in order to recoup your investment by selling it. Some housing experts suggest that five is a more accurate minimum.
The moral of the story? If you’re planning to sell within a year, you’re probably better off renting for a year instead ofbuying.
Sign No. 2: You don’t havea 20% down payment
In most cases, getting a 30-year fixed-rate mortgage will require you to makea 20% down payment. On a $300,000 home, that’s $60,000. That’s a bigchunk of change! So if you don’t have it handy, a 30-year fixed-rate loan mightnot be in the cards.
This doesn’t mean that you absolutely have to put20% down to get a 30-year fixed. Getting approved for this type of mortgage will just be more challenging, and you’ll probably have to payprivate mortgage insurance. PMIis insurance that protects lenders in case you default on the loan.(Historically, buyers with less money invested in a property are more likely to foreclose on ahome.)
So if you have only enough for, say, a 10% down payment, you mightbe better off getting anadjustable-rate mortgage, since 10% down is the threshold typically required for this loan. Meanwhile,anFHA loanletsborrowers make a down payment of as littleas 3.5%.
Sign No. 3: You need cash flow now
Let’s say you do have enough money to make a 20% down payment on a home, but you don’t want to put all your eggs in that basket. Perhaps you want to put the money into a 401(k). Or maybe youneed cash on hand for some other goal, like starting a business. These mightbe reasons to avoid the 30-year fixed and its 20% down payment and consider putting down 10% in anadjustable-rate mortgage instead.
“An interest-only ARM is a great way to increase your cash flow,” says Dineen. During the initial period, you pay theinterest on the loan but not the principal, leaving evenmore money free for other endeavors.
But here’s the rub: “An interest-only ARM is only available to people with great credit scores,” says Dineen. But if you qualify, it can be a boon if you want the freedom to invest your bucks elsewhere.
Sign No. 4: You want to build home equity quickly
A 30-year amortization period is the most common type of fixed-rate loan, but many home buyers also choose to get a 15-year loan. Why? A shorter loan length will allow you to build equity faster. Keep in mind, though, that your monthly mortgage payments will be higher with a shorter loan term.
Depending on your life plans (for example, if you plan to sell the home in 10 years), gaining more equity in a shorter time period mightmake a 15-year fixed-rate loan a better option for you than a 30-year loan. Plus, 15-year fixed-rate loans offer lower interest rates than 30-year loans, meaning you’ll save money over the life of the mortgage.
Sign No. 5: You’re planning to retire soon
Being debt-free in retirement is a priority—or at least a goal—for many baby boomers. Thus, if your golden years are in sight, taking out a 30-year mortgage on a home now mightnot sync well with your retirement plans. A three- or five-year ARM mightmake more sense, especially if you’re planning to sell the property within a few years and live as a renter in retirement.
