When you make the decision to become a homeowner, there is a series of additional decisions that you’ll need to make before you reach that final goal and cross the threshold of your new front door. One of the most important decisions in that series is which type of mortgage loan you’re going to pursue in order to buy the house.
There are several different types of mortgage loan, and it’s useful to understand your options going in so that you can decide which one will be best for your financial future as a homeowner. Here’s a quick primer on what you need to know -- but remember, talking it over with a mortgage broker before you make a final decision is always a wise choice.
Know your lenders
Generally speaking, there are two main categories of mortgage lender:
Conventional lenders include banks, credit unions, or any other non-governmental entities loaning money for mortgages.
Government-sponsored entities (GSEs) are lenders that offer government-backed loans, which often have looser requirements than conventional loans. They include the Federal Housing Administration (FHA), Veterans Administration (VA), United States Department of Agriculture (USDA), and other government entities.
In general, a conventional mortgage loan will require the borrower to put down 20 percent of the total sales price of the home in the down payment. Borrowers with lower credit scores or who don’t have a full 20-percent down payment saved up might have difficulty securing a conventional loan, but they might be able to get approved for a non-conventional loan, which have lower down payment requirements (and for veterans who secure a VA loan, no down payment requirement). Remember that if you’re coming to the table with less than 20-percent down, you will probably be required to pay private mortgage insurance (PMI) on your loan, so that’s an additional expense to consider if you don’t have that down payment fully locked in.
If you’re not sure which lender would be best for you, it’s a good idea to talk to a mortgage broker, who can set you up with several different lenders and types of loans. Even if you qualify for a conventional loan, if you’ve been in the military or you’re a first-time homebuyer, a mortgage broker can explain how a VA or FHA loan might save you money over the long run.
And don’t forget about your own local bank or credit union. If you already have a relationship with a bank or credit union, stop in and ask them to share any information they have available about mortgage loans.
Long or short?
Mortgage loans come in a variety of “sizes” when it comes to the amount of time it will take to pay back the loan. Two of the most popular options are the 30-year mortgage and the 15-year mortgage, and some conventional lenders even offer a 10-year repayment plan for mortgage loans.
Interest rates are usually lower for 15-year mortgages, which means that you’ll end up paying less over the lifetime of the loan -- but you’ll have to repay it twice as quickly as a 30-year loan, so the monthly mortgage payments will be significantly higher. If that’s doable on your budget and you’d like to build equity in your home faster, then a 15-year loan is worth considering.
Conversely, you’ll pay more interest (and at a higher rate) on a 30-year home loan, but the monthly mortgage payments will be lower than for a 15-year loan. (And if you can afford it, making an extra payment or two directly toward your principal -- especially in the early years of your loan -- can mean paying it off months or even years early.)
For most buyers (who likely are also carrying credit card, student loan, and automobile debt), a 30-year loan will make the most sense. But if you can make the payments comfortably on a 15-year loan, it’s worth considering as the money saved over time is significant.
Fixed or adjustable?
Your mortgage loan interest rate comes in two potential flavors: fixed or adjustable. These are referred to as fixed-rate mortgages (FRMs) and adjustable-rate mortgages (ARMs), so you could have a 30-year FRM or a 15-year ARM -- or any other combination of timespan and interest rate type.
A fixed-rate loan has the same interest loan rate throughout the lifespan of the loan, so you’re paying the same percentage rate in year 1 as you will be paying in year 30 of the loan. It gets locked in and does not change, so the monthly mortgage payments don’t fluctuate heavily -- you more or less know what you’ll be paying from the get-go.
An adjustable-rate loan moves with interest rates, which can go up or down. ARMs typically start with a lower interest rate, but that will change as rates do. So your payment can change over time, too -- and rates have been rising after years of historic lows, which leaves no guarantees about when they’ll plateau and how high they might get.
If you’re only planning on being in your home for a couple of years before selling, then that could be a good reason to consider an ARM instead of an FRM, but if you think you’ll stay for a while, then it might be wiser to go with an FRM over an ARM.
Take the points if you can
At this point, the last thing you probably want to think about is paying additional money at closing for anything -- but if you’ve got some cash saved up and your lender gives you the option of paying for mortgage points at closing.
What on earth are points? It’s a way for you to reduce the overall interest paid over the lifetime of the loan by paying your lender at closing. The lender will reduce the mortgage interest rate, so you’re paying money now to save money over time.
If you think you’re likely to be in the home for a long time, this can be a smart way to manage your finances. You’ll have lower monthly payments over the lifetime of the loan and spend less on interest than someone who decides not to take the points. One point is worth 1 percent of the total sales price of the home -- so a point on a $300,000 home would cost the buyer $3,000.
Outsource the work
Is all this nuance making your head spin? A mortgage broker knows all of these mortgage options inside and out, and can quickly tell you whether you qualify for one or should think about another that you’d never considered. And a mortgage broker can also help you figure out how much house you can afford in the first place.
Ask your friends who are homeowners if they would recommend their mortgage brokers to you. Real estate agents also tend to know quite a few mortgage brokers, so ask one you trust to refer you to one they trust. A mortgage broker who knows your financial profile and understands your needs is a huge asset in the search for a home, and it’s a good idea to get one on your side as soon as possible.