Fixed-Rate Mortgages (FRMs)

Most homebuyers are somewhat familiar with what has come to be seen as the conventional mortgage, the 30-year fixed-rate mortgage(commonly abbreviated to 30-year FRM). The logic is simple: The amount borrowed is paid back with same-size monthly payments over 30 years (the term of the loan) at a fixed rate of interest. However one lender's FRM might carry a rate of 8 percent while another lender is offering a similar loan on the same day at 7.5 per-cent or 8.5 percent. That's just one reason why you must shop around to get the best deal.

Another FRM is the 15-year loan, which, obviously, is designed to be paid off in half the time of a 30-year loan. But, although less common, FRMs can also be for 10 years or 20 years. There are even 40-year FRMs, which I don't recommend because very little is saved on the monthly payment, and the total amount you pay back is extremely high. So, short or long, all FRMs are based on the borrower making equal monthly payments over the life of the loan.

Risk and Interest Rate Variation

Here's another variation in FRMs. Mortgage lenders deal in risk, andprice their loans accordingly. What worries them most is that they might not get their money back. What if you default, or fall seriously behind in your repayments? That spells trouble for the lender. These risks, they believe, are higher on longer loans. To compensate, they charge a slightly higher interest rate on a 30-year loan than on a 15-year loan. As I write, the following rates are being offered:

Loan A. 30-year FRMs up to a loan limit of $240,000 available at 7.5 to 8%

Loan B. 15-year FRMs up to a loan limit of $240,000 available at 7 to 7.5%

But, FRMs are not your only option, nor are they the right choice for all borrowers. Since you may be in the latter category, or may be reading this at a time when those very low FRM rates have passed,I will shortly explain some interesting alternatives that are worth your consideration. But first, let's examine some of the fundamental facts of loans in general.

How Does the Length of the Loan Affect Your Repayments?

As you might imagine, the longer the term of the loan the smaller the monthly repayments for any particular amount borrowed (despite the longer loan's interest rate usually being slightly higher). And, although your income level will determine how big a loan you can borrow, it is the term of the loan that will set the size of your monthly repayment. Longer-term loans mean lower payments but, of course, a greater number of payments. This is an important consideration to keep in mind. A 30-year mortgage's monthly payment might be well within your ability to repay (according to the lender's qualifying criteria), where as a 15-year loan's repayment might be too high. This is not to imply, however,that the 30-year mortgage is inherently better; it's not. Any loan you take must be matched to your individual circumstances and your feelings about debt.

To illustrate this point, let's compare two FRMs side-by-side,with only the term being different . Note : I am using $100,000 as the loan amount, but the effect of changing the term holds true for any amount you might borrow. Also note that P+I stands for principal plus interest—more on this later:

Loan A. $100/000 borrowed at 8% over 30 years. Monthly P+I repayment: $733.77

Loan B. $100,000 borrowed at 8% over 15 years. Monthly P+I repayment: $955.66.

In reality/ as we saw earlier, that 15-year loan would typically carry a slightly lower interest rate than the 30-year loan. So, here is the real thiig, two actual loans advertised this weekend in my local newspaper:

Loan A. Amount: $100,000. Term: 30 years. Rate: 7.5%. P+I repayment: $699.22

Loan B. Amount: $100/000. Term: 15 years. Rate: 7%. P+I repayment: $898.83.

Note that the 15-year loan at these rates will cost about $200 more per month, but might still be the better loan for your circumstances. And understand, too, that although longer-term loans carry lower monthly repayments, that does not mean you will pay back less in the end-quite the opposite, in fact. The total interest you'll pay on a 30-year loan is significantly greater than on a 15-year loan.