The decision to buy a house is not one to be taken lightly; it takes planning, determination, thought, and unless you’re paying cash, it also takes a mortgage. Hopefully, you’ve already done your homework about what you can afford, you know the most you’re willing to spend on improvements, and you have made any necessary adjustments to your credit score before you start the home-buying process. Of course, once you’re ready to take the plunge and apply for that loan, you may find you’re faced with yet another huge decision; what kind of mortgage should you get?
If you’ve already started poking around, then you’ve already seen that there are a lot of options out there when it comes to mortgages; 15-year, 30-year, FHA, VA, ARM, and then your head starts swimming faster than Michael Phelps. You probably realize that you need a professional to help you navigate through the world of home loans, but it’s still important for you to know the differences so that you can come to the table armed with the proper knowledge. When you know what you’re dealing with, you can make better decisions and pick the mortgage that makes the most sense for you.
There are a few things to consider when you are selecting a mortgage. You’ll want to decide how long you want your loan to last (the term), and of course, you need to pay attention to the interest rate. The higher the interest rate, and the longer the term, the more money you’ll pay on top of the principal by the time your house is paid off. However, there’s more to it, because there’s yet another feature of a home loan that you need to pay close attention to; is the interest rate fixed or adjustable? If it’s a fixed rate, then no matter how long the term of the loan, your rate will never change. That means no surprises when it comes to your loan payment. On the flip side of the coin, if you have an adjustable-rate mortgage (ARM) your rate can, and most likely will change (more on that in a bit).
Those are just the basics, Understanding Mortgages 101 if you will, but these basics can be mixed and matched in so many different combinations that you end up with a seemingly endless list of options when it comes to choosing a mortgage. Plus, there are special loans that certain individuals can qualify for depending on several factors like income, profession, location, and even situations like buying your first home. Here’s a peek at some of the most popular mortgages and loan terms, and the ones that you’re most likely to hear about when you start the loan process, so you can start to make sense of all of your mortgage options:
Fixed-Rate Mortgage -- As mentioned before, a fixed-rate loan is exactly as it sounds. Your interest rate remains fixed for the life of the loan, so if rates go up, you get to keep your low rate. Of course, this also means if interest rates drop, you’re stuck with your higher rate unless you decide to refinance. Fixed-rate loans come with a bunch of term options, anywhere from 3 years to 10 years to 30. The most popular options are 30-year and 15-year fixed loans. If you know you’re going to be in your house for a long time, or you know your finances or job could be changing in the next few years, this could be a good option for you.
Adjustable-Rate Mortgage -- These loans usually offer tempting, lower rates on the front end, then have the ability to rise after a certain number of years. They come in an assortment of options, the most popular being the 3/1 ARM, 5/1 ARM, 7/1 ARM, and 10/1 ARM. Basically, your rate will remain the same for the number of years designated by the first number, and then your rate can change. How often it changes is dictated by the second number. For example, a 5/1 ARM means that after the first five years, your interest rate will change, and it can change once each year after that. This is a good option if you know you will only be in your home for a few years, say you get a 3/1 ARM because you plan to move in a couple of years. However, just be prepared for things to change; if you end up staying in the home for whatever reason, you could be looking at a significant rate increase.
FHA Loan -- FHA loans are often used by first-time buyers and are good options for those with lower credit or income limits. They are insured by the Federal Housing Administration (FHA) and require a small down payment (3.5%). Since you put less money down upfront, you can pay less upfront for an FHA loan, however, they can be more costly in the long run, with a slightly higher interest rate and the need to carry PMI (private mortgage insurance). Plus, there’s a lot of paperwork and the process can be lengthy.
Conventional Loan -- This is a good option for buyers with a higher credit score and a lower debt-to-income ratio, especially if you are able to come up with a down payment of 20% and avoid private mortgage insurance. Since these loans are backed by private companies and not the government, they can be less complicated to deal with.
Interest-Only Loan -- If you know that your income is going to increase within the next several years, then this type of loan could be a viable option for you, although you have to tread lightly since you never can really predict the future. An interest-only loan gives you the opportunity to pay just the interest on your loan for the first few years of the term, usually no more than 5 years. After this initial term, you begin making payments toward your principal.
VA Loan -- If you are an eligible veteran, a VA loan could make it easier for you to acquire home financing to purchase a house. VA loans are guaranteed by the US Department of Veterans Affairs, and help veterans purchase a home with no down payment needed.
Reverse Mortgage -- This is a term that you may have come across when searching about mortgages, but this isn’t a mortgage that you would get if you are buying a house. Reverse mortgages are usually geared more toward older homeowners who have owned their homes for some time and can borrow against the equity in their home, using their house as collateral.
Now that you have a better understanding of what all of those different mortgage and loan options mean, you can make a more informed decision about which one will work best for your individual situation. Make sure to discuss any potential special circumstances with your lender that might qualify you for a unique loan option such as a first-time homebuyer, or if you’re buying in a certain area. Another vital must when you’re going through the loan process; make sure to avoid doing things that could potentially jeopardize your chances of getting a loan, or things that could potentially raise your rate, like quitting or changing your job, making a big-ticket purchase and other mortgage mistakes.