Figuring Out Which Mortgage Loan Is Right For You
Interest rates are at historic lows, making it a great time to buy a home. If that news excites you and you’re ready to jump into the housing market, your first step may be to shop for a mortgage.
Not so fast.
Low interest rates aren’t the only factor in deciding what type of mortgage to get.
Your down payment, credit score, financial history and how long you plan to stay in your new home (probably not forever) can all help shape the best home loan for you.
Lenders are always eager for business, and there are plenty of different types of home loans meant for different types of buyers. Every buyer is different, but there are some common buyer categories that can make choosing a mortgage easier. Here are five of them:
You Have Good Credit and Savings
A conventional mortgage is a traditional type of mortgage loan. It’s common for people with good or great credit and can afford a down payment of some type.
The lender assumes more risk than it would with a government-backed loan, which we’ll get to next.
Interest rates can be fixed or adjustable, which we’ll also detail later so you can determine which is best for you.
If you have a FICO credit score of at least 620, then a conventional loan may be best for you. The higher your credit score, the lower the interest rate will likely be.
A 20% down payment was normal eons ago, but can now be as low as 3%. The less money you put down, however, the higher the interest rate may be as a way of hedging against some of that extra risk for the lender.
Paying less than 20% down will require buying private mortgage insurance, or PMI. Once your mortgage balance is paid down to 80%, you can get rid of PMI.
You Have OK Credit and Modest Savings
An FHA loan may be best for you because it’s backed by the Federal Housing Authority and requires a lower down payment and credit score, and will have lower closing costs.
The required credit score can be a low as 500 if you put 10% down. To get the FHA’s maximum financing a credit score of 580 and 3.5% down are needed.
FHA loans make it easier to avoid high mortgage fees when you don’t have a 20% down payment. Mortgage insurance is still required, but an FHA loan is common for many first-time buyers because it’s easier to qualify for.
You’re a Veteran
Military veterans can get VA loans with 0% down and low closing costs. VA loans are available to veterans, active military members, or military spouses who meet certain criteria.
The loan isn’t from the Veterans Administration, but the VA guarantees part of the loan from a mortgage lender.
You Want to Live in a Rural Area
If you want to buy a home in a small, rural area, a loan backed by the U.S. Department of Agriculture could be for you.
A USDA rural development single family housing guaranteed loan is a guaranteed loan that requires no down payment and has low mortgage insurance costs.
It’s aimed at rural areas with populations below 35,000. The loan can be used to buy, build, rehabilitate, improve or relocate a house in a rural area.
You Want to Stay in an Area for a Long Time
Fixed-rate mortgages are offered for conventional loans and most government-backed home loans. The principal and interest is spread out evenly over the life of the loan, usually 15 or 30 years, so the same amount is paid every month.
The interest rate is typically higher than an adjustable-rate mortgage, or ARM.
Besides the steady payments, a fixed-rate mortgage is usually a better deal if you plan on staying in the home for more than five years. An adjustable-rate mortgage can stay low for a few years, but then could increase and make mortgage payments harder to afford.
A mortgage calculator can help you figure out how long it will take for the savings from a fixed-rate mortgage over time compared to an ARM and its potentially higher costs over the same time period.
You’re Going to Sell in a Few Years
Moving is common among homeowners, especially first-time buyers. If this is already part of your plan, then an ARM with an interest rate that changes after an initial period can make the cost of a home cheaper than a fixed-rate mortgage.
Adjustable-rate mortgages typically are three, five, seven or 10 years. After the time of a low interest rate, the rate will rise and fall with the financial market.
If you expect to move after the initial rate period, or you’re buying a home that’s well below your budget, then an ARM can be worthwhile.