Fixed-rate mortgage

True to its name, a fixed-rate mortgage means that the interest rate you pay remains fixed at the same level throughout the life of your mortgage loan (typically 15 or 30 years, though there are some shorter-term fixed-rate loans). These are the most conventional mortgages that different types of home buyers take out.

But keep in mind, this fixed-rate peace of mind comes with a price. Fixed-rate loans typically have higher interest rates than the initial rates offered on adjustable-rate loans. More on those next…

Adjustable-rate mortgage

An adjustable-rate mortgage, or ARM, is a home loan that offers a low interest rate for an introductory period. After that period—typically two to five years—the interest rate becomes adjustable up to a certain limit, depending on market conditions. If certain economic indexes change, your adjustable mortgage interest rate could jump after the introductory period ends and your monthly payments could skyrocket. If indexes drop, your monthly payments might stay the same or even go down, as the interest rate decreases. Hence, opting for an ARM can be a bit of a gamble. If you think you might outstay the introductory period, take a good look at the maximum interest rate—it’s often considerably higher than that of a fixed-rate loan.

Nonetheless, if you plan to sell the home within a short period of time, an adjustable-rate mortgage may be preferable. As long as you’re ready to move on before the introductory interest rate period ends, you’ll benefit from the advantage of making lower mortgage payments while you’re living in the home. Tick-tock! And because your lender will be qualifying you on the basis of a lower monthly payment, you could afford a more expensive home than you would with a fixed-rate mortgage.

FHA loan

If your finances aren’t in great shape, a Federal Housing Administration loan could be an excellent home-buying option. FHA mortgage loans were created for low- and moderate-income households that would otherwise be locked out of the housing market due to high debt-to-income or subpar credit—with qualifying credit scores starting at 580. FHA loans also enable you to qualify for a mortgage at the going interest rate with a down payment as low as 3.5%. These mortgages are government-insured, which guarantees that the lender won’t lose its money if the borrower defaults.

Here’s the downside: Because the federal government insures these mortgage loans, borrowers must pay an upfront mortgage insurance premium for this payment option on top of their down payment. Currently the fee is 1.75%—that’s $5,250 on a $300,000 home loan. Borrowers will also have to pay annual mortgage insurance, currently around 0.85% of the borrowed loan amount—or $2,550 more per year on top of your monthly mortgage payments. FHA loans are usually capped at $417,000. (In certain high-cost areas, the limit is $625,000.) This means you have limited buying power when using an FHA loan, although if you aren’t looking to saddle yourself with a huge home loan, this won’t be an issue.

VA loan

The U.S. Department of Veterans Affairs loan program, which began with the creation of the GI Bill of 1944, gives active or retired military personnel the opportunity to purchase a home with a $0 down payment and no mortgage insurance premium. VA loans also offer attractive interest rates.

However, “requirements are fairly stringent” for VA loans, says Miller. VA lenders are typically looking for a credit score of 620, and every VA purchase loan requires a special appraisal that includes the valuation of the property and a close check of the home’s condition—making pre-approval more challenging.

USDA loan

Another type of government-backed mortgage, these loans are offered by the U.S. Department of Agriculture Rural Development in towns with populations of 10,000 or less (you can check the USDA website to see whether your location is eligible). Geared toward low-income buyers, USDA loans can have down payments as low as 0%. The cons? Despite requiring no down payment, they do charge an upfront mortgage insurance fee of 2% of the loan amount, and also carry a monthly mortgage insurance premium of 0.5%, requiring you to pay more over the life of the loan.

Jumbo loan

If you live in a pricey housing market, you may end up with a jumbo loan—a mortgage that’s above the limits for government-sponsored loans. In most parts of the country, that means loans over $417,000; in areas where the cost of living is extremely high (e.g., Manhattan and San Francisco), the threshold jumps to $625,000. (You can check the limit in your local market.)

But keep in mind: Since the amount of money being borrowed is so high, jumbo mortgage loans typically require home buyers to make a bigger down payment—up to 30% for some lenders—and have at least a 680 credit score.

ER Office
Author: ER Office

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