Buying a home is one of the most significant decisions you have to make sooner or later. Except you have loads of cash to dole out, finding a property is one half of the challenge. The other half of this is selecting the type of mortgage that best suits your situation, especially your finances because you will be paying for quite a long time.
When you get a loan to buy a house, you are entering into a mortgage agreement to use the loan to buy a home to repay with interest over some time.
So choosing the right mortgage is not a decision you make in a hurry. You have to consider your options and understand all the conditions involved.
Which Mortgage is Best for You
Deciding on the particular mortgage for your home purchase is a bit complex. That is because there are various types of mortgages, and they are made up of different components. The interest rates involved and the length of the loan are not as straightforward as they sound.
Whether it’s your 4th house or your first when it comes to deciding which type of mortgage is best, the more you know about the types of loans available, the easier the decision on which to choose becomes.
These are the types of loans you will come across when searching.
- Conventional Mortgage
- Conforming Mortgage
- Non-conforming Mortgage
- Fixed-rate Mortgage
- Adjustable-rate Mortgage
- Government-insured Mortgage
- Interest-only Mortgage
- Piggyback Mortgage
Here are a couple of things you need to know about some of the most regular kinds of mortgages available.
When getting a home loan not backed by a government agency, you are likely getting a conventional loan. It would help if you had a good credit score, steady income from stable employment, and the ability to make a minimum of 3% down payment to qualify. Conventional loans are backed by two government-sponsored enterprises, Fannie Mae or Freddie Mac. They buy and sell the most conventional mortgages in the U.S.
To avoid needing private mortgage insurance (PMI), you will be required to make at least a 20% down payment. You can still find some lenders willing to offer conventional mortgages with a lower down payment and no PMI.
Banks charge PMI to cover themselves since borrowers putting down less than 20% have less to lose less on the off chance that they default. As a rule, PMI adds extra to your monthly installment between 0.3 to 1.5% of your loan sum.
Conventional loans can be either conforming or non-conforming mortgages.
Just as the name suggested, these types of loans are bound by maximum loan limits set by Fannie Mae. For 2020, the conforming loan limit for a single-family home is $510,400 for most U.S. and Puerto Rico states.
There are exemptions to the limit if you live in regions assigned as “high cost” by the FHFA. There are 19 states and the District of Columbia with significant expense regions. If you live in one of these areas, the high-end loan limit for a single-family home goes up to $765,600.
Pros of Conforming Mortgages
- They are readily available from a variety of lenders, online and offline.
- You can use it for primary or secondary residences.
- You don’t have to cough out up to 20% as a down payment (mostly from 0 to3%)
Cons of Conforming Mortgages
- The requirement for qualification is stricter than government-backed mortgages.
- PMI may be required for down payments less than 20%
Conforming mortgage might be an excellent idea for you if you are putting 10 to 20% down payment and your credit score is 740 and more.
Non-conforming Mortgages (Jumbo Loans)
These are mortgages not backed by the government and can’t be sold or bought by Fannie Mae to Freddie Mac (government-sponsored agencies – GSEs) due to the loan amount or underwriting guidelines. Non-conforming mortgages are also known as Jumbo loans because the amount exceeds the conforming limits.
Jumbo loans are riskier for lenders, so the requirements are stricter. As a borrower, you are required to make a down payment of 10 to 20% or more and have a strong credit score.
Pros of Non-conforming Mortgages (Jumbo Loans)
- Access to higher lending limits will widen your buying options.
- You get to enjoy competitive interest rates.
- You can buy more expensive homes in areas not designed as high-cost by government-backed agencies.
Cons of Non-conforming Mortgages (Jumbo Loans)
- Required assets are higher than in conforming loans.
- More stringent required to qualify
With non-conforming mortgages, you can borrow more, and with your high score and more down payment. This will give you options when it comes to deciding the type of home you want to purchase.
You can find a lot of government-insured mortgages in the marketplace. A Different government-sponsored entity guarantees these types of mortgages, and the requirements for qualifications are different.
These agencies make home loans accessible to a wide range of low to mid-income buyers and first-time buyers. They have flexible qualifications and down payment requirements. Here are the most common government-insured mortgages
Federal Housing Administration (FHA) Loans
FHA loans are guaranteed by the Federal Housing Administration and have lesser stringent requirements. The criteria for FHA loans open the door for a wide range of borrowers, especially new buyers. An essential feature of the FHA loan is that your credit score and down payment are linked.
You need a minimum of 580 credit score is required to qualify for the lowest down payment of 3% of the loan amount. If your score is within 500 – 579, you will need to raise your down payment to 10%.
With FHA loans, there’s a maximum debt-to-income ratio of 43% for all borrowers, and you can only use this mortgage to fund your primary residence. If your down payment is less than 10%, PMI is required.
Pros of FHA Mortgages
- Non-stringent credit scores and down payment
- Down payments as low as 3.5%
Cons of FHA Mortgages
- Can only be used for primary residences
- Low down payments require PMI.
FHA loans are attractive if you can only afford low down payments and if you have had an unstable credit history but now stable
The U.S Department of Agriculture backs USDA Loans. They guarantee loans to make homeownership possible for low-income buyers who live in rural and suburban areas across the country. This loan may only seem for farmlands, but you can access it to buy your primary residence as a qualified applicant.
USDA loans are best suited for eligible homebuyers who live in rural areas with lower incomes, little save up down payment, and can’t qualify for conventional mortgages.
USDA mortgages don’t come with minimum credit score guidelines. With your 640 or higher credit score, you can enjoy a more streamlined loan process. Down payment for USDA loans can be as low as 0%.
Pros of USDA Mortgages
- No minimum credit score to qualify
- Targeted for low- to mid-income households in rural areas
Cons of USDA Mortgages
- Income and geographical restrictions
- It will usually come with PMI, which increases the monthly mortgage payment.
USDA loan is best suited for you if you have a low income and reside in a rural or suburban area that limits your conventional mortgage qualification. It’s also a great option if you have a credit history that prevents you from qualifying for other types of loans.
Department of Veterans Affairs (VA) Loans
These home loans are dedicated to members of the U.S. Armed Forces and their family members. Suppose you are a veteran or still in active duty, or perhaps, you are a family member like a spouse. In that case, you might qualify for mortgages backed by the Department of Veterans Affairs.
With a VA mortgage, there’s no limit to how much you can lend. However, there’s a limit to how much loan the VA will guarantee, which depends mainly on how much down payment you make.
VA loans have no down payment requirement as long as you don’t buy a home more costly than the VA home limit, and they aren’t dependent upon PMI, which is not typical for other home loan types.
Pros of VA Mortgages
- No down payment is required.
- Flexible credit qualification required.
Cons of VA Mortgages
- Available to only members of the U.S Armed Forces and members of their family
- You need to present evidence to prove eligibility.
Fixed-rate vs. Adjustable Rate Mortgages
When deciding on a mortgage, one of the first things you need to do is understand how the interest rate is treated. You can decide to make your interest rates adjustable, lock it, or even have a combination of both. You might find a mortgage of 30-years with a 5/1 adjustable rate. It means your interest will be locked for five years and, after that, adjusted annually for the remaining 25 years.
Pros of Fixed-rate Mortgages
- Your principal and interest payments will remain unchanged throughout the lifetime of the loan.
- You can have a more precise monthly budgeting since you already know what you are paying as a monthly mortgage.
Cons of Fixed-rate Mortgages
- With long-term loans, you naturally pay more in the end.
- It takes a longer time to build equity in your home.
- The interest rates are higher than rates on adjustable-rate mortgages.
Pros of Adjustable-rate Mortgages (ARM)
- You will pay lower fixed rates in the first few years of buying your home.
- You get to save substantially on interest payments.
Cons of Adjustable-rate Mortgages (ARM)
- Your monthly mortgage payments could become unaffordable, resulting in loan default.
- Home values may fall in a few years, making it harder to refinance or sell your home before the loan resets.
With interest-only mortgages, you get to pay only the mortgage interest for a set period like three to 10 years. At the end of the period, you can pay off the loan with a large balloon payment. Refinance the loan or start making regular monthly payments of principal and interest for the loan’s remaining term.
This type of loan may appear appealing, especially if you are on a budget but ensure you can afford a balloon payment or a significant payment after the period. Otherwise, it may not be worth it.
An interest-only loan is excellent if you intend to stay in the home for a short period or you’re sure of a significant payment.
A piggyback mortgage makes it possible for you to avoid PMI on conventional loans without a 20% down payment. For instance, you put down 10% of the home’s value, take out a home equity loan or line of credit for another 10%, and finance the rest of a home loan.
The downside of this type of loan is that refinancing separate loans, later on, can be complicated. The second loan may have a variable interest rate, which can go up over the long run.
Consider using a piggyback loan if the second home loan cost is not as much as what you’d pay in PMI and you’re not anticipating refinancing in the future.
Having gone through the fundamentals of the various mortgages available for you to choose from, it’s time to start matching them with your dream home. Another strategy is to engage the service of a mortgage professional to help make your decision easier.
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