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When it comes to buying a house, most people know what they prefer: a bungalow or a condo, a hot neighborhood or a sleepy street.
Mortgages, too, come in many styles — and recognizing which type you should choose is just slightly more involved than, say, knowing that you prefer hardwood floors over wall-to-wall carpeting.
First things first: To pick the best loan for your situation, you need to know what your situation is, exactly. Will you be staying in this home for years? Decades? Are you feeling financially comfortable? Are you anxious about changing loan rates? Consider these questions and your answers before you start talking to lenders. (And before you choose a lender, read this.)
Next: You’ll want to have an understanding of the different loans that are out there. There are lots of options, and it can get a little complicated — but you got this. Here we go.
Mortgages Are Fixed-Rate or Adjustable, and One Type Is Better for You
Let’s start with the most common type of mortgage, that workhorse of home loans — the fixed-rate mortgage.
A fixed-rate mortgage:
· Let’s you lock in an interest rate for 15 or 30 years. (You can get 20-year loans, too.) That means your monthly payment will stay the same over the life of the loan. (That said, your property taxes and insurance premiums will likely change over time.)
It’s ideal when: You want long-term stability and plan to stay put.
Here’s what else you need to know about fixed-rate mortgages:
· A 30-year fixed-rate mortgage offers a lower monthly payment for the loan amount (for this reason, it’s more popular than the other option, the 15-year).
· A 15-year fixed-rate mortgage typically offers a lower interest rate but a higher monthly payment because you’re paying off the loan amount faster.
Now let’s get into adjustable-rate, the other type of mortgage you’ll be looking at.
An adjustable-rate mortgage (ARM).
· Offers a lower interest rate than a fixed-rate mortgage for an initial period of time — say, five or seven years — but the rate can fluctuate after the introductory period is over, depending on changes in interest rate conditions. And that can make it difficult to budget.
· Has caps that protect how high the rate can go.
It’s ideal when: You plan to live in a home for a short time or you expect your income to go up to offset potentially higher future rates.
Here’s what else you need to know about adjustable-rate mortgages:
· Different lenders may offer the same initial interest rate but different rate caps. It’s important to compare rate caps when shopping around for an ARM.
· Adjustable-rate mortgages have a reputation for being complicated. As the Consumer Financial Protection Bureau advises, make sure to read the fine print.
A general rule of thumb: When comparing adjustable-rate loans, ask the prospective lender to calculate the highest payment you may ever have to make. You don’t want any surprises.
Conventional Loan or Government Loan? Your Life Answers the Question
Which fixed-rate or adjustable-rate mortgage you qualify for introduces a whole host of other categories, and they fall under two umbrellas: conventional loans and government loans.
Conventional loans:
Who qualifies? Typically, you need at least a credit score of 620 or above and a 5% down payment to qualify for a conventional loan.
· Offer some of the most competitive interest rates, which means you’ll likely pay less in interest over the period of the loan.
· Typically you can get one more quickly than a government loan because there’s less paperwork.
Here’s what else you need to know about conventional loans:
· If you put less than 20% down for a conventional loan, you’ll be required to pay private mortgage insurance (PMI), an extra monthly fee designed to mitigate the risk to the lender that a borrower could default on a loan. (PMI ranges from about 0.3% to 1.15% of your home loan.) The upshot: The lender has to cancel PMI when you reach 22% equity in your home, and you can request to have it canceled once you hit 20% equity.
· Most conventional loans also have a maximum 43% debt to income ratio, which compares how much money you owe (on student loans, credit cards, car loans, and other debts) to your income — expressed as a percentage.
Fannie Mae and Freddie Mac set limits on how much money you can borrow for a conventional loan. A home loan that conforms to these limits is called a conforming loan:
· In most cities, the maximum amount for a conforming loan is $453,100.
· In high-cost areas, such as New York City and San Francisco, the limit is $679,650.
· Limits are revisited annually and are subject to change based on each area’s average home price.
A home loan that exceeds these limits is called a jumbo loan:
· Jumbo loans typically require a higher down payment (up to 30% for some lenders) and a credit score of at least 720. Some borrowers can qualify while putting down 20%, but their credit score has to be higher.)
· They also tend to have stricter debt-to-income requirements, generally allowing for a maximum DTI ratio of 38%.
There are practical considerations to take into account before getting a jumbo loan too, mainly: Are you comfortable carrying that much debt? The answer depends on your current financial situation and long-term financial goals.
Government loans:
Who qualifies? That depends on which government loan you’re looking at.
· Include loans secured by the Federal Housing Administration (FHA), U.S. Department of Veterans Affairs (VA), and the U.S. Department of Agriculture (USDA) Rural Development.
· Are meant to stimulate the housing market and enable folks who may be unable to qualify for conventional loans to still become homeowners.
If you’ve had trouble qualifying for a mortgage because of income limitations or credit:
FHA loans are used by a broad swath of people, including those with lower credit scores and income.
· You can get an FHA loan with a downpayment of 3.5% if you have a minimum credit score of 580. You can still qualify with a credit score below 580 — even with no credit score — but the down payments and other requirements will be much higher.
· FHA loans conform to loan limits set by county; these limits typically range from $294,515 to $679,650 in high-cost areas. You can view the FHA mortgage caps for your county at hud.gov.
· If you get an FHA loan, you must pay an upfront mortgage insurance premium (MIP) and an annual premium of 0.85%. Currently, the MIP is 1.75% of the loan amount — so, $1,750 for a $100,000 loan. This premium can be paid upfront at the mortgage closing, or it can be rolled into the monthly mortgage payment.
Also, a heads-up — the date an FHA loan was issued affects the MIP.
· If you received an FHA loan on or before June 3, 2013: You’re eligible for canceling MIP after five years, but you must have 22% equity in your home and have made all payments on time.
· If you received an FHA loan after June 3, 2013: To stop paying MIP, you’d have to refinance into a conventional loan and have a current loan-to-value of at least 80%.
If you’re in the military, a veteran, or a veteran’s spouse:
· VA loans offer active or retired military (or a veteran’s surviving spouse) a mortgage with a 0% down payment.
· VA loans also can have more lenient credit requirements — typically around a minimum 620 credit score — and lower DTI requirements.
· The VA only allows lenders to charge 1% maximum to cover the costs of originating and underwriting the loan, so you save money at closing. There is, however, an additional upfront, one-time funding fee of 2.15%.
VA loans also don’t charge borrowers mortgage insurance — potentially helping you save a significant chunk of cash on your monthly payment.
Given the benefits, a VA loan is often the best mortgage option for people who qualify.
If your income is limited and you live in a small or rural town: USDA loans are mortgages for limited-income home buyers in towns with populations of 10,000 or less, or that are “rural in character,” meaning that some areas that now have bigger populations are grandfathered in. You can see whether your town is eligible on the USDA’s website.
· USDA loans typically have lower interest rates than non-USDA loans.
· Down payments can be as low as 0%.
· USDA mortgages also have more lenient credit score requirements than conventional loans.
· Income limits to qualify depend on location and household size.
· USDA loans charge an upfront mortgage insurance fee of 1% of the loan amount and annual mortgage insurance premium of 0.35%.
· And USDA loan borrowers must buy a “modest home” — a property with a market value deemed reasonable for the area, though the USDA does not set specific price limitations.
Only a select number of lenders offer USDA loans.
If your job is to help people:
Niche programs, like the Neighbor Next Door from HUD, allows teachers, law enforcement officers, first responders, and government workers — as much as 50% — on eligible homes in revitalization districts.
Note: Downpayment assistance programs offer qualified buyers such things as grants and interest-free loans. Start with your state’s housing finance agency to find options.
Now You Know the Basics. It’s Time to Call for Backup
Speaking of your lender: Ultimately, you’ll be working with your loan officer or broker to narrow down these choices, and to find a loan that works for you and your finances. (Just another reason why it’s important to choose a lender you’re comfortable with.)
Your real estate agent should be able to offer some insight, too. And because they don’t earn a paycheck from your loan selection, their advice about mortgages should be impartial.
You know your stuff. And you know whom to ask for help. Who’s overwhelmed? Not you.
