This is probably the most important question any borrower should ask themselves. Two of the most important things you should know about answering this question is that You Understand The Loan Completely and How Long Am I Going To Be In The House.
It is pretty easy to understand the ins and outs of a 30 year or 15 year fixed rate. But if you choose a loan that has a variable rate or an adjustable rate sometime during the life of the loan, do your homework and understand how the margin works in relation to the index that goes with the loan. Example: a 2.25% margin versus a 2.75% margin is a difference of ½% in the interest rate every time the interest rate adjusts.
You should always estimate how long you will live in the home. If you know this is the last home you will ever buy, you should have a fixed rate term loan with no adjustable rate period. In the long run, you could save a lot of money. However, if you know for sure that you will move in 3 years, 5 years, or maybe 7 years, consider a short term fixed rate loan where the interest rate is fixed for a specific term
then it becomes an adjustable rate. The strategy is that you will sell the house before the adjustable rate term gets started.
It is recommended to never get a loan with a pre-payment penalty, especially if you have good credit. A mortgage broker might use this as a ploy so they can earn a little more commission. If you do pick a loan with a pre-payment penalty, make sure it is a soft pre-payment penalty. In the event you sell the house, there is no penalty during the term of the penalty period
but if you refinance the loan, you have to pay the penalty.
For the borrower with not so perfect credit, you may have to get a loan with a pre-payment penalty in order to get a good interest rate. Unfortunately, the lender that will make a loan to a borrower with less than perfect credit has a hard pre-payment penalty. This means if you refinance or sell the home during the penalty term, you pay the penalty.
Finally, if you are desperate and you are considering an Option ARM/Pick-A-Payment loan, always keep the margin under 2.5% and the pre-payment penalty at 1 year or no penalty period. Lenders and mortgage brokers will try and sell you this loan with greater than 2.5% margins and 3 year pre-payment penalties because they will earn higher commissions. Take control and make them prove to you why the margin should be higher.