Mortgage myth: Nothing tops the 30-year fixed loan

By Janna Herron

AP Real Estate Writer

NEW YORK (AP) -- MYTH: A 30-year mortgage with a fixed interest rate is always the most desirable option when buying a home.

REALITY: Following the crowd isn't always smart. So just because a 30-year fixed-rate mortgage is the most common home loan -- more than two-thirds of borrowers applied for one last month -- that doesn't mean it's right for everyone.

Certainly there's a peace-of-mind that comes with a fixed payment schedule, but homeowners who need a lower monthly bill may find a hybrid adjustable-rate mortgage is a sound option.

It's important to understand that ARMs begin with a fixed-rate period, say five years, before the interest rate resets. The initial rate often is lower than the 30-year mortgage rate, meaning lower monthly payments. When the rate resets, the monthly payment is calculated based on the remaining balance and could end up lower if the borrower put extra money toward the principal.

These loans got a bad rap during the housing bust, but now lending standards are higher and some loans come with rate caps. ARMs backed by the government typically won't increase by more than one percentage point a year and five percentage points over the life of the loan. Pay attention to the terms so a rate increase won't come as a surprise.

ARMs work best for homebuyers who are reasonably sure their income will increase before the rate resets, such as a spouse who plans to return to work. Borrowers can also choose to refinance before the reset, but that may not always be possible if home values fall too far. So homebuyers should feel comfortable they'll be able to pay the higher rate in case plans don't pan out.

Ultimately there are a wide variety of loans available, so it's important to assess your budget as well as how long you expect to be in the home.

Published: Mon, Apr 4, 2011