How to Choose Between Two Mortgages
This case study shows how to compare mortgages
objectively in order to find the mortgage that is right for you.
Step 1: State Your Mortgage Goal
First, state your mortgage
goal. Mortgage goals are the objective criteria by which
different mortgage options will be judged. For a review of this
topic, see the lesson on
setting mortgage goals.
For example, consider two home buyers - Fred and Wilma. Fred intends to
live in his home for the next 30 years. Wilma, however, will live
in her home only until she finishes college - about 4 years. Fred
and Wilma have similar, but not identical, mortgage goals.
- Fred's goal: To minimize mortgage cost over the
30-year life of the loan.
- Wilma's goal: To minimize mortgage cost over the
4-year life of the loan.
Step 2: Gather Mortgage Information
You need info about each mortgage option to assess how well it
satisfies the mortgage goals. For the purpose of this example, we
will assume that Fred and Wilma are trying to choose between
a fixed-rate mortgage and
an adjustable-rate mortgage. The information on each mortgage appears
in the table below.
|Starting interest rate:
||Starting interest rate:
||Months before first rate adjustment:
||Periodic rate cap:
||Maximum rate after adjustment:
||Months between rate adjustments:
Additionally, each loan requires a $25,000 down payment and $3,000 in
other costs and fees. Neither loan requires points.
Step 3: Assess Mortgage Performance
The key to mortgage analysis is assessing how well each mortgage
option satisfies the home buyer's mortgage goal. To conduct this
assessment, Fred and Wilma use the
provided on this site. They begin with the following steps.
- Choose "Compare two mortgages" from the Main Goal dropdown box
of the calculator.
- In the "Options" section, check the box for
"Show amortization schedule".
- Under Loan 1, choose "Fixed-Rate Mortgage" as the mortgage type.
- Under Loan 2, choose "Adjustable-Rate Mortgage" as the mortgage type.
Then, the calculator displays empty text boxes for the data it needs,
and Fred and Wilma enter the required data. The calculator
settings and data entries are shown below.
Describe the Analysis
Describe the Loan
Describe the Rate Adjustment Rules
Months before first rate adjustment:
Maximum lifetime interest rate (%):
Months between rate adjustments:
Describe the Costs Paid at Closing
After Fred and Wilma click the Calculate button,
the calculator produces an
amortization schedule that
shows how total mortgage cost varies from month to month. Total cost
figures from the amortization schedule are reproduced below.
The amortization schedule shows that the adjustable-rate mortgage is the best
choice for Wilma. By choosing the adjustable-rate mortgage, Wilma will save
nearly $15,000 when she pays off the mortgage after 4 years (48 months).
Fred, however, intends to live in his house for the full term of the mortgage - 30
years (360 months). Over that time period, the fixed-rate mortgage is the best
choice. It will save Fred over $50,000.
A Final Thought
This simple example illustrates how important it is for home buyers to
define their mortgage goals before they choose a mortgage. Fred and
Wilma looked at exactly the same mortgages; but they made different
choices, because they had different mortgage goals.