Understanding the pros and cons of different home loans can save you a lot of money. Let's review different loan options:
Fixed Rate Mortgages
Loan loans with repayment terms of 15, 20, or 30 years. With a "fixed rate" of interest, payments will be predictable as they remain the same for the life of the loan. The shorter loan terms will normally provide lower interest rates.
The advantages of Fixed Rate Mortgages are:
- Interest rates that don't rise
- Payments (for principal and interest) that remain the same
- Protection in the event that market interest rates go up
The disadvantages of Fixed Rate Mortgages are:
- Higher initial interest rate than adjustable rate loans.
- Overall higher interest costs over the life of a loan should market interest rates decline.
The Bottom Line: Fixed Rates Loans are generally more desirable when low interest rates can be "locked in" ahead of likely market interest rate increases. Fixed Rate loans offer the greatest benefits for borrowers who lock in low rates AND plan to remain in their home for a long period of time. as variable rate loans
Adjustable Rate Mortgages
(Also called variable-rate loans) offer the benefits of a lower initial interest rate as compared to fixed-rate loans. The interest rate will go up and down over the life of the loan based on market conditions. However, the loan agreement will usually set maximum and minimum rates that will apply. If interest rates increase, so will your loan payments. Conversely, when interest rates go down, your payments are lower.
The advantages of Adjustable Rate Mortgages are:
- You may be able to qualify for higher loan amounts
- You start out with lower monthly payments.
- You pay less for owning a home for a short period of time
The disadvantages of Adjustable Rate Mortgages are:
- Rising interest rates could increase payments sharply
- You can't predict with certainty what your housing costs will be.
- There is more risk, especially if you remain in your home for a long period of time.
- Lower initial interest rates mean it will typically take longer to pay off principal in your home and build up additional equity beyond that which may occur with market appreciation.
The Bottom Line: The lower initial interest rates of Adjustable Rate Mortgages (ARMs) may allow borrowers to qualify for a home/or "more home" at higher loan amounts than they normally would. Lower initial interest rates will typically allow borrowers to pay less for their home over the short term and provide them with the potential to build up market equity. If interest rates should rise sharply however, ARMs can put a considerable amount of financial pressure on borrowers. Most lenders count on the fact that younger-middle aged homeowners with rising incomes can handle higher payments that may result.
Home Equity Loans
Home Equity Loans are sometimes referred to as "second mortgages" With Home Equity loans, your house is used as collateral. The equity you have in your house is the difference between the market value of your house and how much you owe on your original mortgage. For instance, if you owe $200,000 on your first mortgage and your house is appraised at $300,000 current market value, the lender may allow you to borrow up to $100,000 or 100% of your equity. Many lenders protect themselves by allowing you to borrow only up to 80% of your equity.
The advantages of Home Equity Loans are:
- Allow homeowners to borrow against the equity in their home
- Fixed payment terms over the life of the loan
- May provide tax advantages to the owner.
The disadvantages of Home Equity Loans are:
- Interest rates are typically higher than first mortgages
- Borrowers may not "pay down" and borrow additional money
- Homeowners equity is "tied up" and not available if needed
Home Equity Line of Credit
Home Equity Lines of Credit- As with Home Equity Loans (see above), you are borrowing against the equity in your home. However this loan is a flexible one as you draw funds only as needed, and only pay interest on monies borrowed.
Debt Consolidation Loans
Debt Consolidation Loans are loans in which the borrower obtains one loan, and uses the funds to pay off other debts, and often, higher interest rate credit cards as well. The goal is to "consolidate" multiple higher interest rate balances into a single, more manageable, lower cost loan. While debt consolidation loans are very tempting and can lead to overall savings, they should also be carefully considered before moving forward because they can be very risky for undisciplined individuals.
The fact is, it is estimated that seven out of ten people who use a home equity or other type of loan to consolidate debts end up with the same amount, or higher, debt load inside of 24 months. Also, if you're taking on more debt to pay off old debts, it's likely you may not qualify for those low rates being advertised
The bottom Line: Borrowing money to pay off other loans can offer money-saving benefits, but be careful and be disciplined - if you default on payments, you could end up losing your home. That's a very high trade-off for eliminating unsecured credit card debt, especially when you consider that credit counseling and debt management programs can assist you with out-of-control credit card debt.