Before venturing out to buy a home, you may think that a
mortgage is just paperwork: you go to the bank, they decide whether to give you
a loan, and once you are approved, you start making payments. Then, you
discover that there are many types of home loans offered by lenders, each with
its own lending criteria, restrictions, benefits, and drawbacks.
To determine which type of home loan is best for you, you'll
need to consider your credit score, how much you can put down for a down
payment, how big a loan you need, and how quickly you want to pay it off, among
other factors.
Is a conventional loan right for me?
A conventional loan is the most common type of mortgage and the
one that usually comes to mind when you think about a home loan. They are
offered by almost all mortgage lenders. Unlike Federal Housing Administration
(FHA) or Veteran Affairs (VA) loans, conventional loans are not backed by the
government.
What to consider when getting a conventional home loan
Conventional loan are ideal for
borrowers who have a stable income and documented employment history. You
generally can't get a conventional loan if you have a credit score below 620.
Lenders also look at your debt-to-income (DTI) ratio and, if more than 36% of
your monthly income go toward debt payments, you may not be approved.
Conventional loans used to require a 20% down payment, but many
lenders now allow less if the borrower has good credit and a solid income.
Technically, the down payment can be as low as 3% on a conventional loan, but
if you don't make a down payment of at least 20%, you'll have to pay for
private mortgage insurance (PMI) until the balance is paid off. of the mortgage
is 80% or less of the value of the home. You may also have to pay a higher
interest rate if you make a low down payment. Paying the monthly PMI and a higher
interest rate will increase the overall cost of your mortgage, so you need to
weigh whether a lower down payment is worth it.
Is a government-insured mortgage the right choice?
Some types of government-backed loans have more lenient lending
criteria than conventional loans. The main ones you'll see are FHA, USDA, and
VA loans.
Federal Housing Administration (FHA) Loans
FHA loans are backed by the Federal Housing Administration and
are intended to help first-time homebuyers who don't qualify for a conventional
loan. Loan criteria are more flexible with fewer credit scores and income
requirements. Your down payment can be as low as 3.5%, but unlike a
conventional mortgage, you may have to pay for mortgage insurance while the
loan is in force. Interest rates on FHA loans are often a bit higher than
conventional loans, since lending standards are less stringent.
United States Department of Agriculture (USDA) Loans
The US Department of Agriculture offers mortgage loans to low-
and moderate-income homebuyers in eligible rural areas. The USDA has a direct
loan program just for low-income Americans, with extremely low interest rates
and no down payment. It also offers a guarantee program where it backs up loans
made by local lenders (similar to a VA or FHA loan). These loans allow zero
down payment and offer low rates, but you may have to pay for mortgage
insurance.
Loans from the Department of Veterans Affairs (VA)
A VA loan is backed by the Department of Veterans Affairs and is
a home loan specifically for members, former members of the military, and
eligible family members. These home loans allow zero down payment without
private mortgage insurance, and interest rates are generally lower than
conventional loans. To qualify, you must provide proof of stable income that
shows you can repay the loan and you must obtain a VA Certificate of
Eligibility.
What to consider when getting a government-insured home loan
If you don't qualify for a conventional loan, or if your
priority is getting a loan with the lowest possible down payment,
government-insured loans can be a great option. They are ideal for eligible
borrowers with little cash savings.
Government-insured loans are also a good option for homebuyers
with bad credit. An FHA loan allows credit scores of 580 or higher with a 3.5%
down payment and sometimes allows credit scores as low as 500 with a 10% or
higher down payment. While VA loans don't have an official minimum credit
score, most lenders require a score around 620. USDA loans typically require a
score of 640 or higher, and you can't earn more than a certain amount.
(depending on your location).
Keep in mind that not all lenders offer government-backed loans.
You will need to research local and online lenders to find ones that offer
these loans and compare rates before settling on one.
Should I get a fixed rate loan or an adjustable rate
mortgage?
There are two types of interest rates for mortgages: the fixed
rate and the adjustable rate. Fixed-rate mortgages have one interest rate and
one payment amount over the life of the loan.
Adjustable-rate mortgages (ARMs), on the other hand, have an
introductory period in which the interest rate stays the same and is often less
than an average annual percentage rate (APR). fixed. However, after a
predetermined period, it becomes variable. For example, with a 5/1 ARM, the
interest rate would be locked in for the first five years and then adjusted each
year thereafter. The rate adjusts according to market conditions, so it could
go up or down. There are limits to how much you can raise, but you can make
your monthly payment unpredictable.
This is an easy way to find out what type of interest rate is best
for you. If you're going to be in your home for the long term, a fixed-rate
mortgage is often better, as it provides predictability for decades. However,
if you plan to stay in the home for only a few years, an ARM could save you
money if you move before the adjustment period hits, since the introductory
rate is often lower than a typical fixed-rate mortgage.
Should I choose a 30-year or a 15-year mortgage?
Mortgages generally give you several different term options, but
the two most common you'll find are 30-year and 15-year. There are some
important things to know when choosing your term.
First, the shorter your term, the higher your monthly payment
will be because you have less time to pay off the loan. A big plus, though, is
that it also means you'll pay less interest over the life of the loan, since
you're paying off the debt faster, sometimes tens of thousands of dollars less.
Also, interest rates are lower on short-term loans.