Mortgage and Home Financing

For most Americans, a home purchase represents the largest financial transaction of their lives. The mortgage decisions made at purchase - loan type, term, down payment, and whether to pay points - have implications lasting decades. CFP professionals must understand these options to guide clients toward optimal choices based on their individual circumstances.

Fixed-Rate vs. Adjustable-Rate Mortgages

The two primary mortgage types are fixed-rate mortgages (FRMs) and adjustable-rate mortgages (ARMs). Each has distinct advantages and risks.

Fixed-Rate Mortgages (FRMs):

Fixed-rate mortgages lock in the interest rate for the entire loan term, providing payment predictability regardless of market conditions.

• 15-year fixed: Lower rates (~5.44% as of December 2025), faster equity building, higher payments
• 30-year fixed: Higher rates (~6.15% as of December 2025), lower payments, more interest paid overall

Adjustable-Rate Mortgages (ARMs):

ARMs have interest rates that adjust periodically based on a benchmark index plus a margin. Common structures include 5/1, 7/1, and 10/1 ARMs, where the first number indicates years of fixed rate and the second indicates adjustment frequency afterward.

• 5/1 ARM: Fixed for 5 years, then adjusts annually (~5.75% initial rate as of late 2025)
• 7/1 ARM: Fixed for 7 years, then adjusts annually
• 10/1 ARM: Fixed for 10 years, then adjusts annually

ARM Adjustment Caps:

ARMs typically include rate caps to limit adjustment risk:

• Initial adjustment cap: Maximum first adjustment (often 2%)
• Periodic adjustment cap: Maximum per adjustment period (often 2%)
• Lifetime cap: Maximum over loan life (often 5-6% above initial)

Example: A 5/1 ARM starting at 5.5% with a 5% lifetime cap could never exceed 10.5%.

2025-2026 Considerations: With the Federal Reserve signaling potential rate cuts in 2025-2026, ARMs may be attractive for some borrowers betting on declining rates. However, the CFP exam emphasizes that fixed-rate mortgages are generally more appropriate for clients prioritizing payment stability and long-term planning certainty.

Mortgage Points: Paying for Lower Rates

Mortgage points (or "discount points") allow borrowers to pay upfront to reduce their interest rate. One point equals 1% of the loan amount and typically reduces the rate by approximately 0.25%.

Point Economics Example:

• Loan amount: $400,000
• Option A: 6.75% with no points
• Option B: 6.5% with 1 point ($4,000)
• Option C: 6.25% with 2 points ($8,000)

Break-Even Analysis for Points:

Break-Even (months) = Points Cost / Monthly Savings

• Option B break-even: $4,000 / $66 = 61 months (5.1 years)
• Option C break-even: $8,000 / $131 = 61 months (5.1 years)

When Points Make Sense:

• Client plans to stay in home beyond break-even period
• Client has excess cash for closing (not depleting emergency fund)
• Client is in higher tax bracket (points may be tax-deductible)
• Rates are relatively high and unlikely to drop significantly

When to Avoid Points:

• Client may move or refinance within 5-7 years
• Cash is needed for other priorities (down payment, renovations)
• Rates appear likely to decline (refinancing would waste points)

Private Mortgage Insurance (PMI)

Private Mortgage Insurance (PMI) protects lenders when borrowers make down payments of less than 20%. PMI is required on conventional loans with loan-to-value (LTV) ratios above 80%.

PMI Cost Structure:

• Typical range: 0.5% to 1.5% of loan amount annually
• Paid monthly as part of mortgage payment
• Cost depends on credit score, LTV ratio, and loan type

PMI Cost Example:

• Loan amount: $380,000 (95% LTV on $400,000 home)
• PMI rate: 0.8% annually
• Annual PMI cost: $3,040
• Monthly PMI cost: $253

PMI Removal Rules (Homeowners Protection Act):

1. Borrower Request at 80% LTV: You can request PMI cancellation when your loan balance reaches 80% of the original purchase price (not current value)

2. Automatic Termination at 78% LTV: Lender must automatically cancel PMI when balance reaches 78% of original value

3. Final Termination: PMI must be canceled at the midpoint of the loan term (15 years for a 30-year mortgage), regardless of LTV

Strategies to Eliminate PMI Faster:

• Make extra principal payments to reach 80% LTV sooner
• Request new appraisal if home has appreciated significantly (lender policies vary)
• Refinance once equity reaches 20% (consider closing costs)

FHA Loans and Mortgage Insurance Premium (MIP)

FHA loans require Mortgage Insurance Premium (MIP) regardless of down payment size.

*For FHA loans with less than 10% down payment originated after June 2013, MIP is required for the life of the loan. With 10%+ down, MIP can be removed after 11 years.

2026 Loan Limits

Loan limits are adjusted annually based on home price changes. For 2026:

Exam Tip: Know that conforming loan limits are set by the FHFA (Federal Housing Finance Agency) and affect Fannie Mae/Freddie Mac purchases. FHA limits are set by HUD and are tied to local median home prices.

The Rent vs. Buy Decision

CFP professionals often help clients evaluate whether to rent or buy. Key factors include:

Financial Factors:

• Price-to-rent ratio: Home price divided by annual rent. Ratios above 20 often favor renting
• Expected time in home: Generally need 5+ years to justify buying costs
• Down payment opportunity cost: What returns could that money earn elsewhere?
• Tax benefits: Mortgage interest and property tax deductions (if itemizing)
• Home appreciation expectations: Local market conditions

Non-Financial Factors:

• Flexibility needs (job stability, life changes)
• Desire for customization and control
• Maintenance willingness
• Community roots and stability preference

Break-Even Example:

Closing costs (buy): $15,000 Monthly ownership premium over renting: $400 Break-even: $15,000 / $400 = 37.5 months (3+ years)

CFP Exam Tip: The exam often tests understanding that buying is not always better than renting. The appropriate recommendation depends on client circumstances, time horizon, and local market conditions.