Are you thinking of buying a house? With pending home sales on the rise and new single-family purchases expected to increase over 18% through the end of 2019, you’re not the only one. However, the process may not be as straightforward as you might think.
Something as ordinary as financing your purchase is mind boggling with the number of options available. From private lenders to government-backed loans, it’s tough to know which is right for you.
Understanding the Different Types of Home Loans
Knowing what your budget is and saving for a down payment is only part of the equation. The real magic happens when you compare types of home loans to see what is best for your situation.
Before taking the bull by the horns, consider the pros and cons of each mortgage type. Doing your homework ahead of time will help you know what to expect when it’s time to submit an offer.
Fixed Rate Mortgages
Fixed-rate home loans are the easiest to understand. The interest rate stays the same over the entire term of the loan. Whether you have a 15, 20, or 30-year mortgage, your principal and interest payment won’t change.
Pros: Since it locks in your interest rate, there’s no need to worry about fluctuating rates affecting your payment amount. This makes budgeting your expenses from month to month easier because your mortgage payment remains the same.
Cons: The interest you pay with a fixed-rate loan is higher. With more money going toward interest fees, it can take longer to build equity in your home. And if the market plummets, you could get stuck paying a higher interest than the current going rate.
If you like to plan and have more control over your finances, the stability of paying a fixed-rate mortgage might be a perfect fit. Fixed-rate mortgages are also good for homeowners who plan to remain there for most of the loan period since it can take a while for equity to grow.
Variable Rate Mortgages
At the opposite end of the spectrum are variable rate home loans. Unlike with a fixed rate, variable rates can fluctuate with changes in the market. A popular option in this category is the adjustable-rate mortgage. With these, the starting rate is lower but can increase.
Pros: Paying lower interest fees can save you money each month, which can add up to significant savings over the life of the loan. Building equity becomes easier with a low interest rate, too.
Cons: If the market sees periods of increasing interest, your payment could skyrocket. The higher cost could cause you to struggle, leading you to default.
With lower interest helping to increase equity, variable rate home loans are great if you aren’t planning to live there more than a few years.
As a government-backed loan, the Federal Housing Administration (FHA) helps more than a million people become homeowners each year. An FHA mortgage features a lower down payment and more lenient credit requirements.
Pros: FHA loans are available to borrowers with FICO scores as low as 500, but you’ll need a 10% down payment if the score is less than 579. If your score is 580 or higher, you only need to make a 3.5% down payment. This makes it easier to get financing if you’ve had trouble getting other types of mortgages.
Cons: The FHA limits how much you can borrow based on where you live in the U.S. For a one-unit home, you can’t borrow more than $314,827 in a low-cost area or $726,525 in a high-cost area. There are some special exceptions, although it depends on where you want to buy a house.
With lower down payment requirements, FHA loans are popular with first-time buyers who might not have much money saved up. They’re also good for people with a less than stellar credit history who might not qualify for a conventional home mortgage.
Active-duty service members, veterans, and their families have an awesome resource for buying a house. If you qualify, getting a VA loan without a down payment and no mortgage insurance can become your reality. These loans have service requirements that are easy to meet. Generally, 90 consecutive days of service during wartime, 181 days during times of peace, or more than six years of service in the National Guard or Reserves is enough. Before applying to a lender, you’ll need a Certificate of Eligibility from the VA.
Pros: No down payment requirement makes it a piece of cake to jump into homeownership. In addition, not paying mortgage insurance could save you thousands of dollars.
Cons: VA loans are only available to veterans. And not having a down payment limits your initial equity, making it tough to sell unless you plan to stay in the home for most of the term of the loan.
Veterans looking to purchase their primary residence and who are committed to living in one place for several years are excellent candidates for a VA mortgage.
Similar to FHA and VA mortgages, the U.S. Department of Agriculture (USDA) offers a program to provide loans to people with low-to-moderate income. To qualify, the home you want to purchase must be in an eligible area. If it is and you meet income qualifications, it’s an excellent option since there’s no down payment requirement.
Pros: Buying a house with zero down is an amazing opportunity if you’re low on savings. USDA loans come with lower income requirements than some other types of mortgages, and you’ll pay less for mortgage insurance.
Cons: Lenders prefer a credit score of at least 640, though alternative credit sources can help you qualify if you don’t meet those requirements. Establishing equity in your home takes a tremendous amount of time without a down payment.
If you have low or moderate income and are looking to purchase a home in a qualifying rural area, this could be an excellent option. A USDA loan can also help if you don’t have a lot in your savings account or your credit score doesn’t hit the mark.
Conventional Home Loans
Conventional home loans are issued by private lenders. Unlike FHA, VA, and USDA mortgages, conventional loans are not insured by the federal government. They have more rigid qualification requirements, but they can usually save you money over an FHA mortgage. Conforming conventional loans have a few rules set by the government. But non-conforming loans aren’t as regulated, making it even more important to shop and compare offers from different lenders.
Pros: Borrowers can qualify with a down payment of 3% to 20%. There’s no requirement for it to be your primary residence, making it a good option for any property purchase.
Cons: Conventional loans typically require a higher down payment than other types of mortgages, and that could disqualify some potential borrowers. Paying private mortgage insurance is necessary without putting at least 20% down, and that can be costly.
People with a decent credit score, stable income, and who will own the home for most of the term of the loan can benefit. Whether you’re planning to buy a house to live in, a second home, or investment property, a conventional mortgage can help you get the job done.
In order to be eligible for a reverse mortgage, you must be at least 62 years of age. Reverse mortgages may be an answer for a senior citizen who finds that he/she hasn’t saved enough for retirement. The lender will want to see that you have substantial equity in your home before agreeing to a reverse mortgage. Beware, there are good and bad aspects of reverse mortgages.
How to Get a Mortgage
If you’re thinking of buying a home, take some time now to review your finances and credit history. You might not have the luxury of a good FICO score or a flourishing bank account, but you have options.
For instance, an FHA loan with a minimum 500 credit score requirement can open the door to homeownership for borrowers with a subpar history. Plus, mortgages from VA and USDA make it even easier by not requiring a down payment. There are also some additional strategies that can improve your chances at approval for a home loan. While we don’t recommend a 40-year mortgage, methods like the 80-10-10 mortgage may be a good option for your situation.
Knowing what your choices are and learning the ins and outs of different home loans isn’t as complex as you might think. It also gives you a significant advantage when comparing mortgage types and lenders to score you an even better offer.