An important first step for aspiring homebuyers is to decide which type of home loan will best serve their needs. The interest rate, length, down payment, borrower qualifications and extra fees associated with different types of mortgage loans will all play a role in the decision. To help make the choice a bit easier, let’s talk about mortgage basics and compare the advantages and disadvantages of mortgage types.
Related: Pros & cons of buying a starter home
Fixed-Rate vs. Adjustable-Rate Loans
When it comes to understanding types of mortgage loans, the difference between an adjustable-rate mortgage and fixed-rate mortgage is the first thing to consider.
Fixed-Rate Mortgage
Fixed-rate mortgage loans are exactly what they sound like: The interest rate is fixed for the entire life of the loan. The term can vary. These loans offer a steady monthly payment and relatively low-interest rate. Borrowers can usually make extra payments toward the principal if they want to pay off the mortgage faster, as prepayment penalties are rare.
Pro: The monthly payment is fixed, and therefore predictable.
Con: If you take out a fixed-rate loan when interest rates are high, you’re locked into that rate for the entire term — unless you’re able to refinance later and get a lower rate.
30-Year Fixed-Rate Mortgage
A 30-year fixed-rate home loan is by far the most common type of mortgage, according to Freddie Mac. However, because payments are made over a relatively long period, lenders tend to see them as riskier than shorter home loans, and thus ask for higher interest rates.
15-Year Fixed-Rate Mortgage
A 15-year loan may have a lower interest rate, and you will pay less in total interest than you would on a 30-year loan. On the flip side, the shorter term means monthly payments may be much higher.
Adjustable-Rate Mortgage
An adjustable rate mortgage (ARM) has an interest rate that fluctuates after an initial fixed-rate period of months to years. The variable rate is typically tied to a benchmark index rate that changes with market conditions.
ARMs are often expressed in two numbers, like 7/1 or 5/1. A 5/1 ARM typically has a rate that’s fixed for five years and then adjusts every year, up to a cap, if there is one.
Pro: The initial interest rate of an ARM is usually lower than the rate on a traditional fixed-rate loan, so it’s easy to be drawn to the teaser rate, but it could end up costing more in interest than a fixed-rate loan over the life of your mortgage. An ARM might work best for someone who expects to sell the property before the rate adjusts.
Con: Rate increases in the future could be dramatic — though there are limits to the annual and life-of-loan adjustments — typically leaving many adjustable-rate mortgage holders with much higher monthly payments than if they had committed to a fixed-rate mortgage.
Conventional vs. Government-Insured Loans
The most popular type of mortgage, a conventional loan, is originated by a bank or other private lender, and it is not backed or insured by the government. Then there are several types of government-insured loans, some requiring little or nothing down.
Conventional Loan
Conventional loans usually have stricter requirements than government-backed home loans. Lenders typically look at credit scores and debt-to-income ratio, among other factors, in evaluating conventional loan applications.
Your down payment may be less than 20%, but if so, you’ll need to purchase private mortgage insurance (PMI) that insures the lender. PMI can be paid monthly or as an upfront premium that can be paid by you or the lender. PMI needs to stay in place until your loan-to-value ratio reaches 78%.
Pro: A variety of property types qualify for a conventional mortgage, and PMI can make it possible for borrowers to qualify for a conventional loan if they put down less than 20%.
Con: Conventional loans tend to have stricter requirements for qualification and may require a higher down payment than government loans.
FHA Loan
Federal Housing Administration (FHA) loans are not directly issued by the government. Certain lenders can issue FHA loans on behalf of the government, and the FHA insures the loans.
Qualifying for an FHA loan is often less difficult than qualifying for a conventional mortgage, so FHA mortgages can be a good choice for people with less-than-stellar credit scores or a high debt-to-income ratio. With at least a 580 FICO credit score, you might qualify to put just 3.5% down; with a score of 500 to 579, you could put just 10% down. FHA mortgages come with an additional insurance charge called a mortgage insurance premium (MIP) — upfront and annual.
Pros: FHA loans have lower down payment and credit score requirements. Additionally, FHA loans may allow a non-occupant co-signer to help borrowers qualify.
Cons: The MIP stays in place for the life of the loan if the down payment is less than 10%.
VA Loan
The U.S. Department of Veteran Affairs backs home loans for members and veterans of the U.S. military and eligible surviving spouses. Similar to FHA loans, the government doesn’t directly issue these loans; instead, they are processed by private lenders and guaranteed by the VA.
Most require no down payment. Although there’s no minimum credit score requirement on the VA side, private lenders may have a minimum of 580 to 660.
Pros: You don’t have to put any money down or deal with monthly PMI payments.
Cons: There’s a one-time VA “funding fee” on purchase loans, which ranges from 1.4% to 3.6%.
FHA 203(k) Loan
Got your eye on a fixer-upper? A 203(k) loan helps buyers finance both the purchase of a house and repairs. Current homeowners can also qualify for an FHA 203(k) loan to finance the rehabilitation of their existing home.
The generous credit score and down payment rules that make FHA loans appealing for borrowers often apply here, although some lenders might require a credit score above 580. With a full 203(k), the lender will assign a loan consultant to ensure that the right contractor gets hired and the work gets done as promised. A limited 203(k) loan allows you to do cosmetic upgrades worth about $35,000 and is offered by more lenders.
Pros: An FHA 203(k) loan can be used to buy and rehab a property that wouldn’t qualify for a regular FHA loan, and it requires as little as 3.5% down.
Cons: These loans require you to qualify for the value of the property, plus the costs of planned renovations. The rate can be higher than that of a standard FHA loan. Additionally, you’ll pay an upfront and monthly mortgage insurance premium.
Fannie Mae HomeStyle Loan
For fixer-upper fans, an alternative is the Fannie Mae HomeStyle Loan, which requires only 3% to 5% down but a minimum credit score of 620.
Pros: No upfront MIP is required, and you may cancel mortgage insurance after 12 years or once you reach 20% home equity. The rate is often lower than that of an FHA 203(k).
Con: You must meet credit score thresholds.
Conforming vs. Non-conforming Loans
Both conforming and non-conforming mortgages are types of conventional mortgages.
Conforming Loans
Mortgages that conform to the dollar limits set by the Federal Housing Finance Agency are called conforming loans. The limit changes annually, based on federal guidelines. As of 2021, the conforming loan limit is $548,250 for a single-family home in most of the U.S., and goes up to $822,375 in certain higher-cost areas.
Pros: Conforming loans may have lower interest rates and fees than non-conforming loans.
Cons: The amount that can be borrowed is limited.
Non-conforming Loans
Non-conforming loans aren’t as standardized as conforming loans, meaning rules can vary more from lender to lender. This can include features like eligibility, rates and others.
Pros: There may be no limit on loan size, allowing you to purchase a more expensive home. They also can offer people with poor credit who may not qualify for a conforming loan access to a home loan.
Cons: Because non-conforming loans tend to be a bit riskier for lenders, they generally come with higher interest rates and can have higher requirements.
Reverse Mortgage
A reverse mortgage allows homeowners 62 and older to turn part of their home equity into cash. There are several factors to weigh, including the youngest homeowner’s age, the loan rate and costs, the desires of heirs, and payout type.
Pros: The homeowner doesn’t have to make any monthly payments, and they can choose a lump sum, a monthly disbursement or a line of credit — or some combination of the three.
Cons: The interest rate can be higher than traditional mortgage rates. The homeowner will also typically pay mortgage insurance, an upfront fee, an origination fee and third-party fees.
Jumbo Mortgage
Another type of mortgage loan is a jumbo mortgage, which is a home loan above the amounts set by the conforming loan limits, mentioned above. As such, it is a type of non-conforming loan. Also known as a jumbo loan, a jumbo mortgage can be obtained through private lenders.
Pros: Jumbo loans make it possible for buyers to purchase a more expensive property. Plus, there’s no mortgage insurance requirement.
Cons: The application requirements for a jumbo loan can be steep, including a larger down payment, and interest rates and closing costs can run higher.
USDA Mortgage
A USDA mortgage loan is a type of mortgage loan offered to eligible rural homebuyers. The loans are issued through the USDA loan program by the United States Department of Agriculture as part of its rural development program.
Pros: There’s zero down payment required, and interest rates tend to be low due to the USDA guarantee.
Cons: Buyers are restricted to rural areas for this loan type, and there are income limits. Plus, you have to pay a guarantee fee, though it’s typically less expensive than mortgage insurance.
Interest-Only Mortgage
As its name suggests, an interest-only mortgage is a mortgage type where you only make interest payments for a certain number of years at the start of the loan term. Your principal stays the same during this time. Once the initial time frame — usually five or 10 years — is over, your loan becomes fully amortized, meaning you start paying interest and principal each month from there on out. These loans don’t tend to be widely available.
Pros: Interest-only loans can make monthly payments lower during the introductory period, allowing you to use the money that would have gone to principal payment for other purposes.
Cons: Because the homeowner is not making payments toward the principal, they aren’t building any equity. Additionally, their payments will increase significantly once the introductory period ends.
The Takeaway
Among the smorgasbord of different mortgage types, which is best for you? With so many types of home loans, it’s a good idea to do your homework and shop around.
Learn more:
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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Tips when shopping for a mortgage
Shopping for a car: fun, freeing and full of fresh new smells. Shopping for a puppy: heartwarming and full of suspicious smells. Shopping for a mortgage: not particularly thrilling or fragrant but one of the most important decisions many consumers will make in a lifetime.
From assessing what they can afford to nailing down a mortgage type, researching the best rates, and ultimately securing a loan, homebuyers must take many steps when shopping for a home loan.
Here are a few tips and tricks on how to shop for a mortgage loan and what to expect along the way.
Related: What Is an assumable mortgage?
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Reviewing monthly spending and estimating how much they can afford is one way for mortgage shoppers to kick off the homebuying process.
A budget or worksheet can be particularly helpful in determining what’s possible, with line items for the mortgage payment, property taxes, insurance, utilities, maintenance, and funds set aside for emergencies.
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A mortgage calculator is useful for estimating the real cost of a home purchase, allowing consumers to plug and play with the components that comprise a monthly mortgage payment:
- Loan type
- Mortgage principal
- Mortgage interest rate
- Down payment amount
- Loan term
- Estimated property tax
- Private mortgage insurance, or PMI
- Homeowners insurance
- Homeowners association fees
Most mortgage calculators allow homebuyers to enter their credit score for a more accurate estimate. Checking your current credit score can help you determine what type of loan you qualify for.
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In many cases, a higher credit score can help buyers get a lower interest rate, while a lower credit score could mean higher interest rates or the need for a larger down payment.
Knowing this information can help consumers estimate what range of quotes to expect from mortgage lenders or brokers before they start shopping for a mortgage loan.
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One of the first steps a homebuyer might take when shopping for a mortgage is deciding which type of mortgage loan to apply for.
This process could require some diligent comparison shopping to consider the pros and cons of each option alongside financial and personal needs.
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A conventional fixed-rate mortgage offers the same interest rate and monthly payment for the entire term of the loan—typically 15 or 30 years.
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ARMs generally offer lower interest rates than fixed-rate mortgages, but only for a certain time, such as five or 10 years. After that, the monthly payments will adjust to current interest rates.
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A no down payment loan allows buyers to purchase a house with zero money down at closing, except for the standard closing costs.
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An FHA loan is a government-backed loan that allows qualified buyers to put down as little as 3.5% if they meet several requirements, including the payment of mortgage insurance and a limit to the amount of the FHA loan.
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A VA loan is a government-backed loan that allows no down payment and no mortgage insurance for veterans who have served 90 consecutive days during wartime, 180 consecutive days during peacetime, or six years in the reserves.
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A USDA Rural Development loan is a government-backed loan for families in rural areas who are trying to put homeownership within reach. As long as buyers’ debt loads don’t exceed their income by more than 41%, they can enjoy a discounted mortgage interest rate and no down payment.
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Once mortgage shoppers have a better idea of their financial bandwidth and preferred mortgage type, they can begin researching the optimum rates and deals they can get on a home loan.
Mortgage lenders and brokers might offer different interest rates and fees to different consumers depending on the day, even when they have the same exact qualifications. That’s why it can be important not only to understand mortgage basics but to compare what an array of mortgage lenders and brokers are able to quote in the loan estimate.
It can be prudent to bear in mind that mortgage lenders and brokers receive a profit from the loan issuance, so they might be motivated to get consumers to agree to loans with higher fees, interest rates, or origination points.
Shopping around for the best interest rates and deals is a proactive way for homebuyers to avoid more expensive loans and ensure they can strike a deal they’re comfortable with.
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When wondering how to shop for a mortgage lender, it can be useful to start by distinguishing between a direct lender and a mortgage broker:
- A direct lender is a financial institution that assesses whether a buyer qualifies for a loan and offers them the funds directly.
- A mortgage broker is an intermediary between the buyer and financial institution who helps the buyer identify the best direct lender and compiles the information for the mortgage application.
Long story short, mortgage brokers help homebuyers comparison-shop by culling together multiple lender quotes and presenting them all at once. This can be helpful for buyers who don’t want to deal with contacting multiple lenders. That said, the broker typically takes a commission, covered by the buyer, based on the mortgage amount.
In the case of working with a direct lender, it can be a good idea for buyers to deal with a financial institution they already have a relationship with.
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Sometimes a list of questions can be useful when considering whether a mortgage lender or broker is the right fit.
A few constructive questions could be:
- How is the lender getting paid? It’s fairly common for a mortgage broker to get paid a commission on closed transactions. Asking them whether the fee is embedded in the loan origination fee or how their compensation will be facilitated can help make these costs more transparent to the buyer.
- Can they offer competitive interest rates? If so, how long can they lock them in? While mortgage rates tend to be standard across the industry, lender rates can fluctuate based on the buyer’s credit score and financial history. Once the rate is locked in, there’s a guarantee from the lender that they’ll stay the same for a specific period of time, regardless of industry wide fluctuations. Finding out if the lender is willing to offer the best rate and lock it in for 30 to 60 days can help buyers know that they’re covered until closing time.
- What are the typical business hours? Whether it’s a broker or a lender, finding out their availability can be good to determine in advance, especially since many home showings and offers happen on weekends and could require a tight turnaround time.
- Can they provide a breakdown based on different down payment amounts? It can be useful for buyers to see a wide range of cost comparisons when shopping for a loan. Can the lender provide multiple scenarios with different down payment amounts, interest rates, and fees so the buyer can have a knowledgeable conversation about their budget and what’s possible?
- What’s the loan processing time? Asking about the anticipated turnaround time for processing the loan (usually around 43 days) can help determine whether the lender will be able to execute the purchase and sale agreement in time for closing.
- What fees and closing costs can be expected? Inquiring about expected charges is an important way for buyers to ensure no surprises or hidden transaction fees down the line. From origination fees charged by the lender to cover the loan processing to closing costs such as home inspection and appraisal fees, HOA fees or title service fees, a loan estimate can help lay out which charges can be negotiated and which ones are fixed.
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Depending on the loan type, APR rate, whether the interest rate is adjustable or fixed, the down payment option, and potential prepayment penalties or balloon payments, mortgages have many different benefits and risks associated with their purchase.
Working with a lender to calculate how much monthly payments are estimated at currently, five years from now, 10 years from now, etc., can help mitigate potential risks and outline the benefits of certain terms and conditions.
A mortgage worksheet is one way to help illuminate the potential upsides and downsides of a particular mortgage loan alongside the lender.
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After a suitable sampling of lenders have provided detailed mortgage loan quotes, consumers can compare costs and terms and negotiate the best deal. The mortgage worksheet can be helpful in this part of the process as well.
By being transparent about the fact that they’re shopping around for the best quote, can incite lenders and brokers to compete with one another in offering the most favorable option.
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Once comparisons and negotiations whittle the list of quotes to a few, consumers might wish to consult with reliable sources like family members, housing counselors, or real estate attorneys to weigh in on the impending agreement.
Since getting a mortgage loan is often considered one of the most expensive commitments many consumers will make in their lifetime, there’s no harm in asking for a little help when making the decision.
Whether it’s a friend who already knows how to shop around for a mortgage or an opinion leader in the buyer’s close personal network, mortgage shoppers might want to review their loan documents with a trusted, well-informed source before they sign anything.
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While getting prequalified for a loan involves consumers submitting their financial information and receiving an estimate of what the lender could potentially offer, preapproval means the lender has conducted a full review of the consumer’s income and credit history and approved a specific loan amount for, typically, 60 to 90 days.
This approval usually comes in the form of a letter.
Homebuyers can benefit from getting preapproved for a mortgage in many ways. Not only does it offer them the opportunity to discuss loan options with the lender, but it also helps them understand their budget and the maximum amount they could borrow.
In some cases, a preapproval letter also indicates serious intention to purchase a property. This can prove particularly helpful in competitive markets and bidding wars. Sellers will often go with a preapproved buyer over a prequalified buyer, since the loan will need to be approved for the final purchase regardless.
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How to shop for a mortgage? First, figure out how much you can comfortably afford, and then choose a loan type, research interest rates, and compare what lenders offer. Finding the right loan is as important as choosing the right home.
Learn More:
- What is mortgage forbearance?
- Understanding mortgage basics
https://www.sofi.com/learn/content/mortgage-basics/
This article
originally appeared on SoFi.comand was
syndicated by MediaFeed.org.
SoFi Loan Products
SoFi loans are originated by SoFi Lending Corp (dba SoFi), a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law, license # 6054612; NMLS # 1121636 . For additional product-specific legal and licensing information, see SoFi.com/legal.
SoFi Home Loans
Terms, conditions, and state restrictions apply. SoFi Home Loans are not available in all states. See SoFi.com/eligibility for more information.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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Featured Image Credit: SARINYAPINNGAM / istockphoto.
