By: Daniel Bortz
Need a mortgage to buy a home? Oh course you do! So you’ll want to consider carefully which type of mortgage is right for you. That’s right, you have options! And it’s important to choose a home loan that best suits your financial circumstances, because it can save you major money and make sure those payments will likely remain within your financial reach.
In this fourth installment of our Stress-Free Guide to Getting a Mortgage, we’ll walk you through the choices, and the pros and cons of each.
Fixed-rate mortgage
True to its name, a fixed-rate mortgage means that the interest rate you pay remains fixed at the same level throughout the life of your loan (typically 15 or 30 years).
The majority of home buyers prefer fixed-rate mortgages because they offer long-term stability, says Katie Miller, vice president of mortgage lending at Navy Federal Credit Union. And indeed, they are ideal if you plan to stay in your home for at least five years—and the longer you stay, the more sense a fixed-rate mortgage makes.
But keep in mind, this peace of mind comes with a price. Fixed-rate loans typically have higher interest rates than the initial rates offered on adjustable-rate loans. More on those next…
Adjustable-rate mortgage
An adjustable-rate mortgage, or ARM, is a home loan that offers a low interest rate for an introductory period. After that period—typically two to five years—the rate becomes adjustable up to a certain limit, depending on market conditions. If certain economic indexes change, your rate could jump after the intro period ends. If indexes drop, your payments might stay the same or even go down. Hence, opting for an ARM can be a bit of a gamble. If you think you might outstay the introductory period, take a good look at the maximum interest rate—it’s often considerably higher than that of a fixed-rate mortgage.
Nonetheless, if you plan to sell the home within a short period of time, an ARM may be preferable. As long as you’re ready to move on before the introductory period ends, you’ll benefit from the advantage of making lower payments while you’re living in the home. Tick tock! And because your lender will be qualifying you on the basis of a lower monthly payment, you could afford a more expensive home than you would with a fixed-rate mortgage.
FHA loan
If your finances aren’t in great shape, a Federal Housing Administration loan could be an excellent option. FHA loans were created for low- and moderate-income households that would otherwise be locked out of the housing market due to subpar credit—with qualifying credit scores starting at 580. FHA loans also enable you to qualify for a mortgage with a down payment as low as 3.5%. These mortgages are government-insured, which guarantees that the lender won’t lose its money if the borrower defaults.
Here’s the downside: Because the federal government insures these loans, borrowers must pay an upfront mortgage insurance premium. Currently the fee is 1.75%—that’s $5,250 on a $300,000 home loan. Borrowers will also have to pay annual mortgage insurance, currently around 0.85% of the borrowed loan amount—or $2,550 more per year. FHA loans are usually capped at $417,000. (In certain high-cost areas, the limit is $625,000.) This means you have limited buying power when using an FHA loan, although if you aren’t looking to saddle yourself with a huge home loan, this won’t be an issue.
VA loan
The U.S. Department of Veterans Affairs loan program, which began with the creation of the GI Bill of 1944, gives active or retired military personnel the opportunity to purchase a home with a $0 down payment and no mortgage insurance premium. VA loans also offer attractive interest rates.
However, “requirements are fairly stringent,” says Miller. VA lenders are typically looking for a credit score of 620, and every VA purchase loan requires a special appraisal that includes the valuation of the property and a close check of the home’s condition.
USDA loan
Another type of government-backed mortgage, these loans are offered by the U.S. Department of Agriculture Rural Development in towns with populations of 10,000 or less (you can check the USDA website to see whether your location is eligible). Geared toward low-income buyers, USDA loans can have down payments as low as 0%. The cons? They do charge an upfront mortgage insurance fee of 2% of the loan amount, and also carry a monthly mortgage insurance premium of 0.5%.
Jumbo loan
If you live in a pricey housing market, you may end up with a jumbo loan—a mortgage that’s above the limits for government-sponsored loans. In most parts of the country, that means loans over $417,000; in areas where the cost of living is extremely high (e.g., Manhattan and San Francisco), the threshold jumps to $625,000. (You can check the limit in your local market.)
But keep in mind: Since the amount of money being borrowed is so high, jumbo loans typically require home buyers to make a bigger down payment—up to 30% for some lenders—and have at least a 680 credit score.
So now that you know the types of mortgages you can get, it’s time to start shopping for one!
