Mortgage Loans: Which One is Right for You?
As you shop for a new home, you may notice that there is an overwhelming amount of options at your disposal. The style of the house, the amount of rooms, and the extra square footage are just a few of the choices you need to make. The same range of choices also presents itself when it's time to choose the best mortgage for you.
The mortgage that you choose has many variables, including the interest rate and loan term. As you shop through different lenders, it's important to understand the loan term options available to you. Follow this guide to break down the different types of loans, their advantages and disadvantages, and how to know if it’s right for your mortgage needs.
Fixed Rate Mortgages
For the conservative borrower, the fixed rate mortgage is perhaps the most common type of home loan. It gets paid off over a set amount of time (15, 20, 30 years), at a set interest rate so the borrower always knows what to expect. There is comfort in the fact that market rates will rise and fall, but the interest rate remains constant. This is the real selling feature of this mortgage type. It is ideal for those home buyers that are purchasing their forever home, or at least plan of settling in for many years.
• 30-Year Fixed Rate Mortgage: One of the more common fixed rate loan options is the 30-year loan. This loan is ideal for homeowners who are looking to settle down in a forever home. Families with children often choose this type of loan term for its smaller monthly payments. The fixed rate of the loan will remain in place throughout the entire 30-year span, thereby affording you a consistent payment amount each month.
• 15-Year Fixed Rate Mortgage: If you've recently acquired a high-paying job or are looking to pay off your home as quickly as possible, you may want to consider a 15-year fixed mortgage. Because of the larger payments and quicker payoff, a 15-year fixed rate mortgage will also come with lower interest rates than a 30-year mortgage. This type of mortgage payment is ideal for people who come into large sums of money through settlements, winnings, or family inheritance.
One major advantage of applying for a fixed rate mortgage is that a home buyer will know exactly how much they’ll be paying on their home each month, and over the course of the loan. As the market fluctuates and interest rates rise, you’ll never have to worry about your rates.
By the same token, if interest rates drop, you may end up paying more than those in a variable rate mortgage. The only way to take advantage of a new low rate would be to refinance, but this could come at a cost to the borrower.
A balloon mortgage is similar to a 30-year fixed rate mortgage for the first 5 to 7 years. This means that you will have traditional payments and interest rates that remain the same. Once this set period has passed, the remaining balance of your home is due. That remaining balance is a large sum of money, hence the term "balloon payment." This final payment will give you complete ownership of the home and many use this option to quickly pay off a home. If you cannot afford to make the balloon payment at the end of the loan, you can refinance the mortgage at the current interest rate and extend the balloon payment date.
• Ideal for homeowners who don’t plan on staying in their home for more than a few years.
• Balloon rate mortgages typically have lower interest rates compared to a fixed-rate mortgage, which means lower monthly payments. This leads to borrowers qualifying for larger loans they otherwise would – putting that dream home within reach.
• The obvious disadvantage to a balloon mortgage is the large sum of money that remains to be paid back at the end of the loan term. After a short maturity period of 5 – 7 years, the homeowner easily risks getting into a large pile of debt if they can’t make that final payment.
• This loan may work for those borrowers who know they will be coming into a large sum of money, but is most likely not suitable for the average working class borrower.
Adjusted Rate Mortgages – (ARMS)
If you're looking for the lowest interest rate to start off, an adjusted rate mortgage may be your best option. These mortgages start off with a low interest rate that is guaranteed for a fixed amount of time. After that time has passed, the interest rate may rise or fall based on current housing markets. If you're planning on living in the home for less than 10 years, an ARM can provide you with low interest rates during the majority of that time. It will allow you to save money and pay more toward the principal of the home.
Three words - Low interest rates. Isn’t that what everyone wants in a loan? If you're not planning on staying in your home for long, or if you don’t mind to refinance in a few years, this is the loan for you. Like the balloon loan, due to the lower interest rate, you’ll likely qualify for a higher loan amount with an adjusted rate mortgage. This is a great option for those home buyers with a lower credit score.
It is inevitable that your rates are going to fluctuate overtime. You must ask yourself if you’re capable to offset that rate increase? You don’t want to rely on refinancing to bail you out of a hard spot.
The last mortgage type on the list is government-backed mortgages. Here’s a high-level review of the different types of home loans backed by the government.
• Federal Housing Administration (FHA) loans: A popular option for first-time home buyers. If you can’t scrape together a large down payment or have a credit score at or above 500, this loan is an excellent option.
• Veterans Administration (VA) loans: Veterans and active military can qualify for a zero-down payment mortgage. These loans come with many other benefits such as no mortgage insurance payments.
• United States Department of Agriculture (USDA) loans: USDA loans are designed to help develop the rural areas of the United States. This loan helps home buyers to purchase and renovate rural homes with no down payment and a below-market mortgage rate.
• If you have poor credit, the FHA approval requirements tend to be less stringent than those for conventional loans. A homebuyer with a credit score of 500 can qualify for this type of loan.
• Government-backed loans only require a down payments of 5-10% of the purchase price of the home. An FHA loan can be go as low as 3.5% down payment.
• Government-backed loans are generally competitive and offer low interest rates.
• With FHA loans, you are required to pay two premiums. The first is the upfront mortgage insurance premium (MIP) which is 1.75% percent of the mortgage. So, if you’re mortgage is $275,000, your premium would be $4812, upfront. You’re also required to pay an annual MIP which is rolled into your monthly mortgage payments.
• Anytime you’re dealing with a government-backed loan, the process is more complex and requires a lot more paperwork than a conventional loan.
Going over your loan term options will help you make an informed decision that you won’t regret down the road. Choose a loan term that makes the most sense with your budget and long-term goals. Once you’ve reviewed all the loan terms, be sure to browse our reviews and explore the different rates and options provided by top lenders.