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.

Fixed-Rate Mortgage		Adjustable-Rate Mortgage
Loan term:	30 years	Loan term:	30 years
Starting interest rate:	7.5 percent	Starting interest rate:	6.0 percent
Loan amount:	$250,000	Loan amount:	$250,000
		Months before first rate adjustment:	12 months
		Periodic rate cap:	0.5 percent
		Maximum rate after adjustment:	10 percent
		Months between rate adjustments:	12 months

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 mortgage calculator 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

Main goal:

Options:

Show amortization schedule
Include mortgage insurance
Include hazard insurance

Include property tax
Include prepayments
Include tax deductions

Describe the Loan

Loan 1

Loan 2

Mortgage type:

Loan term (in years):

Loan amount ($):

Interest rate:

Describe the Rate Adjustment Rules

Months before first rate adjustment:

Periodic rate cap (%):

Maximum lifetime interest rate (%):

Months between rate adjustments:

Describe the Costs Paid at Closing

Down payment ($):

Points (%):

Other costs and fees ($):

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.

Year	Fixed-rate mortgage: Total cost	Adjustable-rate mortgage: Total cost
4	$351,557	$336,482
30	$657,290	$710,940

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.