How Do Mortgage Interest Rates Work?

If you are a first-time homebuyer, or are thinking of buying your first home; understanding how mortgage interest rates work can be a bit overwhelming, but it needn't be. First let's explain what a mortgage, and the interest rate, are.

A mortgage is a loan received from a lender to buy a house. The interest is the percentage of money that you pay the lender each year, in return for lending you the money. It really is that simple. And even though a specified interest rate is money you pay in order to use their money to purchase a house, all is not lost. Mortgage interest is also tax deductible. So, when you prepare your taxes this spring, you will need to fill out the 1040 Schedule A to itemize your deductions. You will also need to get from your mortgage lender, form 1098 which is your mortgage Interest Statement. You will not need to attach this to your taxes when you file, since your financial institution will send a copy directly to IRS, but I bundle ours up with each year's financial papers.

Leaving tax benefits aside for a few moments, and let's take a look at a couple of different types of interest rates and how they work. It should make it much easier for you to decide which type of interest you would like to pursue.

1. Fixed Interest Rate - this interest rate does not change for the entire life of the loan. Your payments will always remain the same, and if the interest rates do eventually drop considerably, you can always refinance your loan to get a lower interest rate if you so choose. This is especially the way to go if you plan on staying in your home for a long period.

2. Adjustable Rate Mortgage (ARM) - there are predetermined adjustment intervals, either up or down depending on the interest rate fluctuation. In the beginning, the interest rates are a little bit lower than they are with the fixed interest rates, which makes it the way to go if you only plan on being in the home a short period of time before selling. You must be careful with this type of loan interest though, because if the interest rates go up considerably, and you can't afford the higher payments you could be in some financial trouble.

There is a booklet put out by the U.S. Department of Housing and Urban Development that explains the mortgage and interest process. You should receive this from the financial institution that you apply for your mortgage from, but if you would like to take a look at it beforehand, go online to http://www.downpaymentsolutions.com/documents/buying%20your%20home%20booklet.pdf. It will help you to better understand the mortgage and interest process.

The mortgage and interest that you decide on will depend upon your lifestyle and the type of payment that you have the ability to pay. The important thing is that you make an informed decision.