A mortgage is the single largest personal loan you will get and possibly the most confusing. You need to ask, “What is the best mortgage for me?” and “What is the easiest loan for me?” We’ll answer those questions and give you some tools.
Fixed Rate Vs Adjustable Rate
Fixed Rate: A fixed rate has the same interest rate through the entire loan life. The monthly payment never changes.
Adjustable Rate (ARM): The interest rate is adjusted to match a specific financial index. Payment amount can vary drastically. ARMs have lower initial interest rates than fixed rates.
Hybrid ARM: This has a fixed rate for a certain time period, then the rate adjusts. A 5/1 ARM has a set five years loan rate and then adjusts annually.
If you plan to stay in a house for many years or are a first-time buyer, a fixed rate is generally your best option.
There are two more types of mortgages. They are interest-only and balloon loans. In an interest-only loan, you pay only interest for a set period of time. Eventually, you will pay off the principal and your monthly payment will skyrocket. In a balloon loan, you pay interest or interest and some principal for a certain amount of time. At the end of that time, you owe the entire amount as a lump sum. No matter how good these sound, they are a Very Bad Idea.
Conventional or Government-insured
A conventional loan is not insured by the federal government. Conventional loans are available from private lenders like credit unions, mortgage companies, online lenders, and banks.
- Generally put down 20% of purchase price
- May not pay private mortgage insurance unless less than 20% down
- Must have a lower Debt to Income ratio
- Must have a FICO score of 670 or higher
A government-insured mortgage is insured by the federal government. There are generally more requirements, but the terms can be much more affordable.
FHA: Federal Housing Administration mortgages are managed by Housing and Urban Development.
- Available to everyone
- Best for first time buyers or those without a mortgage for more than three years
- Down payments can be as low as 3.5% of purchase price
- Can be gift from a family member or seller
- Will have to pay a Mortgage Insurance Premium
- Usually easier approval process than conventional
- More flexibility for lower credit ratings or previous bankruptcies or foreclosures
- Higher Debt to Income (DTI) ratio allowed
- Interest rates are generally lower than conventional loans
VA Loans: The U.S. Department of Veterans Affairs (VA) offers loans to military service members and families.
- Borrowers may finance 100% of the purchase price
- No credit score requirements, although many lenders require a score of 580-669
- No mortgage insurance
- Must meet one of these requirements
- Veteran on active duty for 181 days during peacetime
- Veteran on active duty for 90 days during war time
- Served at least 6 years in the National Guard or Reserves
- Currently on active duty for at least 90 continuous days
- Military discharge due to hardship
- Un-remarried spouse of a veteran who died in service or from a “service connected disability”
USDA/RHS Loans: The United States Department of Agriculture offers loans to rural borrowers who meet certain qualifications. Loans are managed through the Rural Housing Service (RHS).
- Must be rural, low or moderate income residents unable to obtain adequate housing
- Income must be no higher than 115% of the adjusted area median income
Jumbo vs. Conforming Loans
Two government-controlled corporations, Freddie Mac and Fannie Mae, purchase and sell mortgage-backed securities. They buy mortgages and sell them to investors.
Conforming Loan: This type of loan conforms to Freddie and Fannie guidelines and falls within maximum size limits.
Jumbo Loan: These exceed Freddie and Fannie limits. This loan is a higher risk so jumbo borrowers need excellent credit and larger down payments.
15- or 30-Year Mortgages
Your lender will offer a fifteen or thirty year mortgage, although there are are five and ten year mortgages. The shorter the loan, the more you pay and the faster you pay off your mortgage. A shorter loan builds equity faster and you pay less interest.
When you are comparing rates make sure that the amount includes property tax, homeowner’s insurance, and the principal payment. If you put down less than 20% (on a conventional loan), you may have to include mortgage insurance as well.
In general, a thirty-year mortgage is your best deal. If you can pay extra every month you can turn a thirty-year into a fifteen-year mortgage. If you can’t make that extra payment in a particular month, it won’t hurt your credit rating or put you in default.
If your credit rating is not stellar or a lower interest rates, you can buy points (also called mortgage points or discount points). Basically, you pay money upfront for a lower interest rate. Points cost 1% of the amount you are borrowing and lowers your interest rate by 0.25%.
Let’s say you are taking out a $200,000 mortgage with a 4.25% rate.
- 1 point will cost you $2,000 and lower your rate to 4%
- For monthly payment (without taxes or insurance) you would pay $984 at 4.25%. If you purchase a point, your monthly payment will drop to $955
- It will take 68 months (5.6 years) to recoup the $2,000 spent on that point
- After 68 months, you will have a $29/month savings
Should you buy a point? If you intend to stay in your home for many years, yes. You will save a lot on interest. In our example, at the end of thirty years without a point, you would pay $154,200 in interest. With one point, you would save $10,500 and pay only $143,700 in interest. That is a huge return on $2,000!
Fees and Costs
Comparison shop to make certain you are getting the best mortgage for you. Write down what you are told and get the same information from other lenders.
Ask if there is a prepayment penalty. This means that you will be fined if you pay your loan more quickly or refinance. Avoid these.
Next, ask about fees. You will pay for certain tasks or may be able to negotiate these into your home purchase. There is not a set rate, so comparison shop. Fees include:
- Home appraisal – how much the house is worth in comparison to similar homes sold recently
- Credit report
- Survey – is the property line clearly delineated and not encroached ?
- Title search – are there liens on the house? Does it belong to the seller?
- Inspection – what is wrong with the house and what must be repaired to meet loan requirements
Before you look, investigate mortgages and get pre-qualified for a mortgage. You will know how much you can borrow, and won’t fall in love with a home out of your price range. Some real estate agents require a pre-qual before showing a home, especially one on the high end.
Finally, a mortgage broker may be a great option. A broker has access to different lenders and can show you a variety of loans that have different advantages for your unique situation. Just remember, the best type of mortgage for you depends on your finances and credit.
Apply for a Mortgage Today
Compare the Lowest Rates from Mortgage Lenders
Disclaimer: We are not lawyers and we are not giving you any type of legal advice. This information is only intended to be helpful for the reader