Mortgages are not a one-size-fits-all type of financial product. Depending on a borrower’s personal financial profile and what they are trying to accomplish short-term and long-term, one specific type of mortgage is likely more appropriate than another product at any point in time. Studying the pros and cons of each type of loan will help borrowers make an educated decision about which loan is best for them.
Borrowers must select the most suitable mortgage by evaluating the variables that impact them the most. Below are the questions homebuyers should ask themselves before moving forward with a home loan product.
- How much down payment do you have?
- How much payment can you comfortably afford?
- How long do you expect to own the home?
- Do you expect your earnings to increase or decrease in the future?
- Is your income steady or do you experience fluctuations in income levels?
- How much money do you have set aside for financial emergencies?
- How risk-averse are you?
- How stable is your job or business?
- How much down payment do you have saved?
- Are you likely to be transferred suddenly?
- What is your credit score?
Below are some different types of mortgages worthy of review.
Conventional Home Loans
This type of loan is the go-to type of loan for many borrowers. These loans are backed by the federal agencies Freddie Mac and Fannie Mae which makes them plentiful, low-risk loans for banks. It is important to realize that conventional loans are either categorized as conforming or non-conforming loans.
As the titles imply, conforming loans fall within strict guidelines and limit the amount of the loan amount. The reason this fact is important to a borrower is that it determines the interest rate charge.
Conforming loans offer lower interest rates than non-conforming loans. The most popular non-conforming loan is a jumbo loan which is defined as a high-dollar loan for a specified amount which is determined by the locale. Jumbo loans typically start around a half-million dollars, plus or minus a few thousand depending on the area. The loan amount guidelines change regularly.
This type of loan is perfect for risk-averse borrowers with a steady income who can prove steady employment, assets, creditworthiness, and income. Borrowers with 9 to 5 work profiles with at least two years of employment and good credit scores often apply for this type of mortgage loan.
1. These loan products can be used for primary residence, vacation home, or investment properties.
2. Borrower closing costs are usually reasonable as banks compete for mortgage customers.
3. In many cases, borrowers can get into this type of mortgage for as little as a three percent down payment.
4. PMI insurance can be canceled once you have 20 percent equity in your home.
5. Fixed-rate and adjustable-rate mortgage products are available.
1. Borrowers must have a credit score of 620 or higher to qualify for this type of loan.
2. Borrowers can’t have more than a 45 to 50 percent debt ratio to qualify.
3. Borrowers who put down less than 20 percent on a home loan will have to pay for Private Mortgage Insurance (PMI).
4. Securing a conventional loan is a document-intensive exercise that requires borrowers to prove income, credit acceptability, assets, and stable employment history.
FHA Home Loans
Since 1934, Federal Housing Administration (FHA) loans have been making the dream of homeownership come true for Americans. The FHA insures the loans are underwritten and made by private lenders who assume little to no risk in these deals. This agency was created for the sole purpose of making homeownership affordable for more Americans by offering liberal underwriting guidelines that include lower credit and down payment requirements.
This type of loan is perfect for first-time homebuyers because of the low down payment and minimum credit score requirements.
1. Borrowers with credit scores as low as 580 can qualify for this loan.
2. The down payment can be as low as 3.5 percent.
3. Closing costs are typically low.
4. Energy improvement costs can be rolled into the mortgage.
5. The loan can be used for 1-4 unit real estate properties.
6. A mortgage for a mobile home or factory-built home can be obtained.
7. Reverse mortgages are available for seniors who are 62 years of age and older.
8. Adjustable and fixed-rate mortgage products are available.
1. Borrowers must pay for mortgage insurance every month.
2. There is a requirement to wait for a full two years after bankruptcy before a borrower can apply for a mortgage.
3. This type of loan is for owner-occupied residences only.
VA Home Loans
VA loans are guaranteed by the U.S. government and are specifically designed for veterans, certain military spouses and service members as an excellent no down payment path to homeownership. These loans are made by private lenders and offer many people without perfect credit and little cash on hand the chance to buy a home.
This loan is hard to beat for any borrower who meets the basic requirement of being an eligible veteran or service member. Buying a home with no down payment and extremely lenient underwriting requirements is a true gift.
1. This home loan program is one of the only mortgage options left where borrowers do not have to pay a down payment.
2. No PMI insurance is required.
3. These loans generally offer more competitive rates since lenders enjoy a lower risk position than on other types of loans.
4. These loans offer liberal underwriting guidelines making it easier to qualify.
5. Closing costs are limited with many borrowers paying nothing down at closing.
6. Fixed-rate and adjustable-rate mortgage products are available.
1. Strict guidelines limit who can apply for this type of loan to veterans, some military spouses and service members.
2. There is a loan limit of about $484,350 placed on VA loans in most areas of the country.
3. There is a funding fee of about 2.15 percent for first-time homebuyers that is added to the loan amount.
Fixed Loan Products
Fixed loans are a practical choice for many risk-averse borrowers who want to pay the same amount every month without having to worry about a payment adjustment that will require a higher payment in the future. While a fixed loan term can run for any number of months, typically 30-year and 15-year terms are the most common.
This safety does cost borrowers some in terms of rate. Since banks are tying up their investment money on a fixed-rate loan for a long period of time with no ability to adjust to changing market conditions, borrowers pay for having peace of mind and guaranteed payments. That is why fixed-rate loans charge a higher interest rate than variable loans.
There is some good news for fixed-rate customers who want to take advantage of lower rates. Refinancing makes it possible for borrowers to obtain a new loan at a better rate.
ARM Loan Products
An adjustable-rate mortgage provides an excellent financing option for borrowers who want the lowest starting interest rate and payment. This low beginning rate typically lasts for a period of three to about ten years before adjusting to a new rate per the terms of the agreement.
While the advantages of an adjustable-rate mortgage can be tempting for borrowers who zero-in on a low “teaser” payment, it is important to remember that the rate will most likely adjust upward at some point in the future. That is why understanding the terms of the loan is so important. Some ARMs adjust in only a year.
Borrowers who know they will be moving in a short period of time are likely to benefit from an ARM. It is important to find out if there is a prepayment penalty. This type of penalty for selling your home too soon may negate any payment advantage earned by having a lower interest rate.
Nervous borrowers contemplating an ARM can evaluate loan products with caps for a better option. A cap on the interest rate is defined as a limit on how high the interest rate can increase in a given period of time. Even conservative buyers will consider an adjustable-rate mortgage with a cap in some cases.
As the largest expenditure that most consumers ever make, a home loan has the potential for either building wealth or losing it based on making the right loan choice. Risk-averse borrowers typically select a fixed-rate mortgage while buyers who know they won’t be staying in a home for the long-term often go with a variable rate loan to take advantage of lower payments. Savvy borrowers do their homework before making this important decision that can have a dramatic impact on their financial health.