How to choose interest rate on your mortgage?

Failure to select the best interest rate for your loan could result in higher loan costs.

In times when Fed is increasing the short term rate, it would be wise for you as a borrower to know how to choose interest rate for your mortgage. The decision on your interest rate will impact your finances in the future. Thus, it is not something that you should neglect when shopping around for the best mortgage. Before applying for a mortgage, you should be sure that you choose interest rate that will be best for you.

Before making any final decision regarding the type of interest rate you want to pay, you should have certain starting point. Therefore, your search for most adequate interest rate for your mortgage should start by gathering information about couple of things. Namely, you should know the following:

  • Available interest rates and mortgages in accordance to your situation. What types of interest rates and mortgages in general are you eligible for?
  • Expectations about the movement of interest rate in the future;
  • Your financial situation now and in few years’ time;
  • Your investment plans;

First and foremost, you should be aware that there are two basic types of interest rates: fixed interest rate and adjustable interest rate. Each of the two types of interest rates has its own advantages and disadvantages. It is usually accepted that during period of low interest rates you should go for fixed rate mortgage. On the other hand during period of decreasing interest rates you should opt for an adjustable rate mortgage in order to capture the possibility for decrease in interest rates. In addition, it is also suggested that, in times of high interest rate volatility and uncertainty about the future interest rates, you should choose fixed rate mortgage, so as to eliminate any uncertainty about your interest rate cost.

The following guidelines can help you in the process of deciding which type of interest rate to choose for your mortgage:

  • If you plan to repay additional portion of your mortgage principal during the first couple of years, then you might want to choose adjustable rate mortgage. Meaning that you should see whether you plan to pay only your monthly payment, or you will make additional payments toward your principal amount.
  • Be aware about your future income. Adjustable rate mortgage means that your monthly payments will increase over time. Make sure that you will be able to pay the increased monthly income, without any adverse effect on your life style. Thus, know beforehand the possibility for an increase in your income, and whether this increase could cover the increase in your monthly payments. Because of the concept of negative amortization you could increase your debt level.
  • Consider your debt to income ratio because it is an important factor when applying for a mortgage and other types of loans. Adjustable rate mortgages might have lower monthly payments during the initial period. Meaning that you will be able to purchase more expensive home, because you can qualify for bigger loan.
  • Don’t forget the prepayment terms because some banks charge a prepayment penalty. Thus, if you decide to pay portion of your mortgage, or entire mortgage amount before its expiration, you might end up paying additional prepayment fees and penalties.
  • The opportunity to lock in your interest in times when interest rates are rather low, and the possibility for additional decrease is not feasible. This means that fix interest rate mortgage would be a wise decision. This is in a sense that most probably interest rates would go up in the long run, but you will be paying the low interest rate.
  • You could choose adjustable rate mortgage when buying your home, and after the fixed payment period is over, you could refinance.

 Before deciding on the type of interest rate you want for your mortgage, you must first take into account the level of your income in the future, your life style, potential movement of interest rates in the future, possibility for refinancing, etc. There are numerous factors to consider when deciding on the type of interest rate you want to pay. It is highly important that you make your decision based on adequate information. Keep in mind that a wrong interest rate could cost you hundreds of dollars and more. Therefore, pay attention and time to gather relevant information before you make your final decision.