Depending on your present and future financial situation, and the type of home you are interested in, you will need to take a mortgage loan that best fits your circumstances. The loan that is the perfect match for you may end up being a poor choice for somebody else.
Therefore, it is important to know about the various types of mortgage loans in existence, along with the upsides and downsides that come with each type of loan.
By definition, a fixed-rate loan is a mortgage where the interest rate stays the same for the entire duration of the loan. You will end up paying the same amount each month no matter what changes are made to the market rate, which makes it a great option for people who are planning to stay in their home for several years. While you are protecting from any rapid rises in interest rates, you also do not benefit from any dramatic drops in interest rates.
The fixed-rate loan also provides stability because there are no guesses or surprises when it comes to monthly payments, and so it benefits those who have a reliable source of monthly income. Within a fixed-rate loan, you have the option of going short-term (~15 years) or long-term (~30 years).
Short-term fixed-rate loans have the advantage of paying less money in interest over the course of the loan, but the disadvantage of overall monthly payments that are more expensive. Overall, you get to pay off the loan quicker
Long-term fixed-rate loans have the advantage of making smaller monthly payments, but the disadvantage of paying more money in interest due to the higher interest rates (you also end up paying interest for a longer period of time). In general, lenders are taking a risk by loaning money to a buyer for longer periods of times.
An adjustable-rate mortgage (ARM) will have the interest rate fixed for a set period of time, and then the rate will occasionally change in order to reflect the present interest rates. There are two specific types of ARMs that home buyers can opt for: Hybrids, and Interest-only.
Hybrids have you paying off your mortgage at a fixed interest rate for a certain amount of time, followed by the interest rate changing when a given time interval passes by. For example, take a 7/1 ARM. This means that your interest rate will stay the same for 7 years, and then year 8 will see a change in the interest rate. From that point forward, the interest rate will change once every year (hence the ‘1’) for the entire duration of the loan.
Interest-only is the same thing as a Hybrid, except that you only pay interest for a set period of time before the interest rate changes, at which point you’re paying off both the interest AND the principal mortgage balance. If you had a 7/1 Interest-only ARM, you only pay off interest for the first 7 years, and then you have to start paying the principal balance plus the interest from year 8 and onward. You would also be subject to the fact that the interest rate would adjust once a year (hence the ‘1’).
It is worth noting that the Interest-Only is the riskier option of the two, being better suited for people who are almost certain that they will be able to reliably pay off their mortgage once they have to start paying the interest and their principal balance on a monthly basis.
Although the initial interest rate (a.k.a. ‘teaser rate’) may be lower than that of a fixed-rate loan to begin with, fluctuations in market trends can lead to higher interest rates over the duration of the loan. For home buyers who are unprepared, the sudden rise in interest rate could leave them in a difficult financial situation. At the same time, home buyers will benefit in paying less interest if the rates happen to decline.
Unlike the fixed-rate loan, the adjustable-rate loan is best suited for those who intend to pay off their loan at a faster rate, and/or before the time period where the interest rate will change. People who opt for this type of loan do not intend to live in their home for several years. There is also the possibility of the home buyer anticipating interest rates to decline over time.
Typically, a conventional mortgage loan (either fixed-rate or adjustable-rate) will have you putting down at least 20% of the home purchase price. However, there are people who are unable to pay such a large sum of money out of pocket, and/or cannot qualify for this type of loan due to factors such as a bad credit score and large sums of debt. In this case, a government loan (i.e. guaranteed by the federal government) may be a better choice.
The most common type of government loan is the Federal Housing Administration (FHA) loan, in which you can put down a minimum of 3.5% instead of 20%. This long-term fixed mortgage option is clearly beneficial for those who are struggling financially. The only catch is that you have to pay two types of interest: An upfront mortgage insurance premium (MIP), and an ongoing monthly MIP as well.
Another popular government loan is the Veteran’s Administration (VA) mortgage loan. Provided you meet certain qualifications, you can get a home for 0% down payment without any monthly insurance fees. However, you will have to pay an initial funding fee and the VA loan only applies to primary residences (i.e. it cannot be used as an investment tool to take on a second home).
Getting pre-approved for a mortgage loan before looking at houses is emotionally and financially responsible. On one hand, you know what you can spend before bidding on properties. And on the other hand, you avoid falling in love with a house that you can’t afford.
The pre-approval process is fairly simple: Contact a mortgage lender, submit your financial and personal information, and wait for a response. Pre-approvals include everything from how much you can afford, to the interest rate you’ll pay on the loan. The lender prints a pre-approval letter for your records, and funds are available as soon as you and the seller can get to the closing table.
Though it’s not always as simple as described above, at the end of the day, it is your responsibility to ensure that you are fully aware of your past and present financial situation. This will help you get pre-approved faster, and in turn determine which type of mortgage loans you qualify for. Every type of mortgage loan has its pros and cons, so you need to choose one that is right for you.
Let Us Lend and our qualified mortgage lending partners, can help you find a loan that is the right fit, having decades of experience in helping veterans, first-time homebuyers and the credit challenged. If you feel you’re ready and want to move forward with purchasing a home, click the button below and let’s see how we can help you complete this life goal!