You’ve paid less and saved up for a downpayment, you’ve researched the neighborhood and you have a plan. Now all you have to do is secure your financing and you will be well on your way to buying a home.
However, not all mortgages are created equal. Since this loan may be the biggest loan ever (and one that will certainly affect your finances for the foreseeable future), you need to know more about your options before signing on that dotted line.
Let’s talk more about the many types of mortgages you may encounter and a little bit about their benefits for different consumer segments:
traditional fixed rate mortgage
A “traditional” mortgage means that your lender is offering you credit without any insurance from the federal government. However, they meet standards that qualify for endorsement from either Fannie Mae or Freddie Mac, two government-sponsored institutions that purchase most traditional mortgages — and which may allow you to qualify for a loan with 3% of your home’s purchase price as a downpayment.
There’s a catch: Unless you can make a downpayment equal to 20% of the home’s purchase price, you’ll need to pay for private mortgage insurance (PMI). This will increase your monthly payments – although you can usually refinance or get the lender to cancel the PMI once your equity reaches 20%. There are also options to avoid PMI with less than 20% downpayment. These options will depend on your credit score and downpayment amount.
A “fixed-rate” mortgage simply means that your interest rate, once locked in, will remain the same for the life of your loan. This is a huge plus if you buy when interest rates are at rock bottom (like now), and it approximates your monthly payment.
Fixed-rate mortgages typically come in 15-year and 30-year terms, although you may be able to negotiate with your lender for something in between. Typically, a shorter repayment period rewards you with a lower interest rate but leaves you with a larger monthly payment and vice versa.
This is by far the most common type of mortgage. To get one, you need good credit, a debt-to-income ratio that supports monthly payments, a stable employment record, and the all-important downpayment.
traditional adjustable-rate mortgage
These loans are like traditional fixed-rate mortgages — with one notable difference: Your initial interest rate is locked in for the short term only. One year and five year terms are not uncommon.
After that period ends, your interest rate will adjust annually to market conditions. This ultimately means that your monthly payment could suddenly go up or down, depending on what’s going on with loan rates.
Why would anyone take such a loan? Well, lenders may be more inclined to offer an adjustable-rate mortgage (ARM) loan with an introductory interest rate higher than what you can get on a fixed-rate loan, especially when average interest rates are high. You may be prepared to gamble that interest rates will fall in the future, allowing you to refinance a fixed-rate mortgage with a better interest rate.
The low initial interest rate on an ARM loan can also be attractive to those who are buying a home when interest rates are high, but have no intention of staying for the next 10 or 20 years.
These are a type of traditional mortgage, but they are called “non-conforming” loans because they are too large to have any form of federal backing or guarantees by Freddie Mac and Fannie Mae.
In 2021, a loan of $548,250 . more than Takes you to “jumbo” territory (for most of the country, except in some high-cost areas). To secure one of these loans, you need a great credit score and a downpayment of at least 20%. You can expect your lender to do more checks on your cash reserves, employment history and the appraised value of the home.
The federal government operates several programs designed to help more Americans become homeowners by insuring loans against default. This prepares lenders to take a chance on borrowers who cannot meet the stringent requirements for traditional loans.
Your options include:
- FHA Loans: Backed by the Federal Housing Administration (FHA), these loans can help lenders secure a mortgage for less money for damaged credit or downpayments. If your FICO score is 600 or higher, you can get an FHA loan Only 3.5% of the purchase price of your home as a down payment.
- VA Loans: These loans, which are Supported by the US Department of Veterans Affairs, are restricted to members of the US military (both active duty and ex-servicemen), and do not require either mortgage insurance (PMI) or a down payment. Closing costs are generally minimal and the money out fee for each loan can usually be included in your monthly payment.
- USDA Loans: Backed by the US Department of Agriculture, these loans are designed to encourage homeownership in rural areas. as long as you’re at home a suitable areaEven borrowers with low or moderate incomes and little or no money for downpayments may be eligible for the loan.
unusual types of mortgages
As you dig into your options, you may also find some unusual types of mortgages. Some of them include:
- Balloon Mortgage: This can be a risky mortgage to take. Initially, you have very low monthly payments – but that payout rate will wear off after a few years. When this happens, you usually have to pay off the entire balance. If you aren’t able to refinance before that balloon payment is due, you might not be able to manage.
- Construction Loans: If you are building your home from the ground up, you may want a construction loan that is tied into a mortgage. Generally speaking, you’ll need excellent credit, proof of your financial stability, and a solid downpayment to be eligible.
Accessing Down Payment Funds
Apart from placing several types of mortgages before you, you also have a few options for accessing down payment funds:
- Our Capital: Borrowers can use their money for downpayment. The money must be in an account and cannot be cash or “mattress money”. A lender is required to verify the source of downpayment funds.
- Retirement Accounts: Some retirement plans allow withdrawals without penalty if the money will be used for a downpayment.
- Gift Fund: All types of loans allow the buyer to receive gift money from a family member, or someone the lender can establish, is in a relationship. The gift giver must complete a gift affidavit and will likely provide a bank statement showing that they have available funds for the gift.
Which mortgage is right for your budget and goals? Ultimately, this is a decision only you can make – but you should make it in consultation with a lender you trust. Don’t let anyone talk you into a mortgage with terms that make you uncomfortable – or terms you don’t understand.