What Mortgage is Right for You?
Before you sit down face-to-face with a mortgage lender or broker, the first step is to be informed. There are many types of mortgages out there, and it’s important to get an idea of what they are so you can review your options with confidence. Just like there are different kinds of homes, there are different ways you can pay for them.
There are three basic ways of categorizing mortgages:
(1) Fixed-Rate vs. Adjustable-Rate (ARMs)
(2) Conventional vs. Government-Backed
(3) Jumbo vs. Conforming
Fixed-Rate vs. Adjustable-Rate Mortgages (ARMs)
Fixed-rate and adjustable-rate mortgages are both conventional options. Within these are a handful of options based on what type of interest rate you’re comfortable paying and how long the mortgage lasts. Conventional mortgages require great credit and a strong financial background.
A fixed-rate mortgage is the more traditional route, where you pay off the loan over a set period of time (10, 15, 20 or 30 years) at an interest rate that doesn’t change no matter how much market rates may fluctuate. You will pay the same amount, at the same monthly rate, for years with no changes. This gives you more stability because you won’t have to worry about how much the market changes; if rates fall, you can choose to refinance. A fixed-rate is a conservative choice in the long term with great security, but if you don’t think you’ll be in that house for long, you may want to browse for other options. Usually with a fixed-rate mortgage, you’ll be required to have an excellent credit score and pay a down payment of 20 percent or more. If you can’t make this down payment, you have to pay for Private Mortgage Insurance (PMI) each month, in which case, you might want to consider other options.
An adjustable-rate mortgage (ARM) begins with a fixed interest rate at a lower percentage than a traditional fixed-rate mortgage for the first couple years, followed by annually fluctuating monthly payments that adjust in tandem with the change in market rates. If interest rates rise in the latter portion of your mortgage repayment, your rates will be higher – but if interest rates drop, then you’ll pay less on those monthly payments. The most popular adjustable-rate mortgage is the 5/1 ARM, providing the introductory rate for five years and after that, the interest rate can change every year. A 5/5 ARM has a fixed rate for five years, followed by adjustments to the rate every five years. There are many different variables of an ARM. A lot of times, ARMs come with rate caps, which are limits set on how much the interest can increase over the life of the loan. Like fixed-rate mortgages, if you can’t pay the 20 percent down payment, you are required to pay mortgage insurance. If you don’t plan on living in your home for long, or if you plan on refinancing in the near future, this may be the right option for you.
Conventional vs. Government-Backed Mortgages
Additionally, you’ll need to decide if you want to use a government-backed mortgage or not. Any loan that isn’t backed by the government is a conventional loan. Conventional loans are completely dealt with in the private sector, and don’t require mortgage insurance as long as you pay a down payment of 20 percent or more. Government-backed mortgages are protected by the federal government, meaning if the borrower defaults, the lender has security. These require that you pay monthly mortgage insurance and an upfront premium to assist in the safety of the lender. There are three common government-backed mortgages, which include FHA (Federal Housing Administration), VA (Veterans Administration) and USDA mortgages (United States Department of Agriculture).
FHA mortgages are insured by the Federal Housing Administration with management coming from the Department of Housing and Urban Development (HUD). They are designed for borrowers who can’t make a hefty down payment or may have a subpar credit score, which makes them especially appealing for first-time homebuyers. FHA mortgages allow for down payments anywhere from 3.5 percent to 10 percent, depending on what the borrower’s credit score looks like.
The next government-backed mortgage option is a VA mortgage, which is only offered to qualifying veterans, active military personnel and military families. These are backed by the Department of Veteran Affairs with zero-down, lower interest rates, no mortgage insurance and more. If you qualify, it’s almost always going to be the best move.
Another common government-backed mortgage is a USDA/RHA mortgage, backed by the United States Department of Agriculture and managed by the Rural Housing Service (RHS), a subsidiary of the Department of Agriculture. These loans are designed to assist low- to moderate-income Americans in the purchasing or renovation of rural homes. The perks are no down payments and low interest rates.
Jumbo vs. Conforming Mortgages
Lastly, you’ll want to distinguish the size of your loan, which categorizes you into either a conforming mortgage or a jumbo “non-conforming” mortgage.
Conforming mortgages follow Fannie Mae and Freddie Mac’s conforming guidelines, which consider credit, income, assets and loan amount. Conforming loans are under $424,100 and anything that’s over that amount is considered jumbo or “non-conforming.”
Jumbo mortgages exceed the federal conforming guideline of $424,100, but that can vary by state and county. Jumbo loans allow you to purchase a more expensive home, which represents higher risk for the lender because of the size. If you opt for a jumbo mortgage, borrowers usually need excellent credit and larger down payments. They also must pay higher interest rates compared to the conforming alternative.
When deciding what mortgage program is right for you, weigh these important factors and become an informed borrower to make sure you approach your financing options appropriately. Regardless of what you choose, pay attention to interest rates; a drop in rates could provide an opportunity to save money through refinancing after your initial mortgage. The interest rate, size of the loan and whether it’s backed by a government entity or not are all important aspects to keep in mind while you begin your search for the right mortgage, and the right home.
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