Step 2: Select a Mortgage

Understanding and selecting the right mortgage is fundamental in the loan process; that's why it's so important to understand your options. You'll need to consider two things: which loan type best meets your home buying needs, and which loan term offers the ideal repayment schedule.

Loan Types

Most home loans fall into one of two general categories: fixed-rate and adjustable-rate mortgages (ARMs).

Fixed-rate mortgages have interest rates that stay the same for the entire life of the loan. The main advantages of this type of mortgage are:

* You will have constant monthly payments throughout the life of the loan.

* You'll be protected from rising rates, so your principal and interest payments can never increase, no matter how high interest rates rise.

On the other side, ARMs have interest rates that adjust periodically based on market conditions. The main characteristics of this type of mortgage are:

* The initial rate is fixed for an introductory period (usually one to ten years), and is typically lower than for a fixed-rate mortgage. After that, the rate adjusts annually or semi-annually based on a market index, but it can't go above a predetermined adjustment cap.

* Because of the lower initial rate, you may be eligible for a larger loan amount with an ARM than with a fixed-rate mortgage.

Loan Terms

The “term” of a loan is the period of time you will spend repaying it. The most common loan term is 30 years, but other options are also available, such as 40-, 20-, 15- and 10-year mortgages.

Whether you're better off with a longer-term loan or a shorter-term loan depends on a number of factors, most notably your monthly income and your long-term financial goals. Comparing two fixed-rate loans with different terms:

* The longer-term loan will offer lower monthly payments. This may be a good option if you're on a tight budget or would prefer to direct your monthly cash flow toward other investments or expenses.

* The shorter-term loan will mean higher monthly payments, but you'll be repaying the loan faster and saving money on interest.