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Which Type of Mortgage Is Best For You?

December 16th, 2019 8:02 AM by Jackie A. Graves, President

Understand your options for home loans and get help from a mortgage professional.

 

WHETHER YOU'RE BUYING A home for the first time or the fifth, applying for a mortgage can be a daunting process. It's easy to get overwhelmed with svo many different types of home loans available.

But the more you know going into the process, the easier it will be to choose the right loan.

Common types of mortgages you'll come across include:

  • Conventional loans
  • Conforming loans
  • Nonconforming loans
  • Fixed-rate loans
  • Adjustable-rate loans
  • Government-insured loans
  • Interest-only loans
  • Piggyback loans

What Are the Different Types of Mortgages?

Here are a few things to keep in mind about some of the most common types of home loans, which sometimes overlap.

Conventional loans. One type of home loan you've likely seen before is a conventional loan. These are any mortgages that are not part of a government program.

"Conventional is sort of the one everybody kind of defaults to," says Rick Bechtel, head of U.S. residential lending at TD Bank and a former U.S. News contributor. "It is by far the most common mortgage program out there. But there are a lot of other good options out there, depending on your specific situation."

Conforming loans. These loans follow certain rules set by the government, as well as by government-sponsored entities Fannie Mae and Freddie Mac, which provide backing for conforming loans.

In 2019, the standard limit for a conforming loan is $484,350 for a single-family home in most markets and up to $726,525 in high-cost areas. Other requirements include:

  • credit score of 620 or higher for fixed-rate mortgages, or 640 or higher for adjustable-rate mortgages.
  • A debt-to-income ratio of 36% or lower, or up to 50% in certain situations.
  • A down payment of at least 5% with most loans, or 3% in certain situations.

Conforming loans tend to be less risky for lenders, so they may offer better terms than nonconforming loans.

Nonconforming loans. These conventional loans do not follow one or more of the standards created for conforming loans. The most common type of nonconforming loan is a jumbo loan, which exceeds the standard loan limit for conforming loans. Jumbo loans tend to have higher credit score and down payment requirements, as well as lower debt-to-income ratio limits.

Other nonconforming loans may be available if your credit score doesn't meet the minimum requirements, you're self-employed or your circumstances are unusual.

Opt for a nonconforming loan if the loan amount or your financial situation doesn't meet conforming standards set by Fannie Mae and Freddie Mac.

Fixed-rate loans. As the term suggests, these loans have a fixed interest rate. This means your principal and interest payments won't change for the life of the loan.

The rate on a fixed-rate option usually starts out high compared with adjustable-rate loans, but you'll have the benefit of knowing what your rate will be until you pay off the loan, sell the house or refinance.

Consider a fixed-rate loan if you're planning on staying in the home for a while and don't want to deal with the uncertainty of an adjustable rate that can fluctuate. Terms for fixed-rate loans are generally 15 or 30 years.

Adjustable-rate loans. Most adjustable-rate mortgages start at a relatively low fixed rate for an initial period – typically three or five years but sometimes seven or even 10. After that, your interest rate will increase or decrease annually based on the market rates at the time.

Some adjustable-rate loans set a limit on how high or low your interest rate can go each year and over the life of the loan.

These loans can be less expensive upfront than fixed-rate loans. But if you're planning on staying in your home for longer than the initial fixed-rate period, you'll need to make sure you can afford a potentially higher payment or you can refinance to a fixed-rate option.

An adjustable-rate loan could be worth considering if you're only planning on living in the home for a few years or you're confident you'll be able to refinance into a fixed rate before the adjustable period ends. It could also make sense if you expect interest rates to go down in the future.

Government-insured loans. A handful of mortgages are backed by government agencies. These loans have special features and eligibility requirements that can make them a better fit for certain homebuyers.

  • FHA loans. Backed by the Federal Housing Administration, these loans may allow you to get into a home with a credit score below the standards for conforming loans. With a 3.5% down payment, you may qualify with a credit score of 580 or above, and with a 10% down payment, you may be able to qualify with a 500 credit score. That said, FHA loans charge upfront and ongoing mortgage insurance premiums that can be difficult to shake. Consider an FHA loan if your credit score isn't high enough for a conventional loan.
  • VA loans. Insured by the U.S. Department of Veterans Affairs, these loans are available for certain members of the military community, as well as their spouses and other beneficiaries. They don't have a down payment or credit score requirement, and you won't be on the hook for ongoing mortgage insurance premiums. There is, however, an upfront funding fee. If you qualify for a VA loan, it may be your best option due to the favorable terms, but still take the time to compare other options just in case.
  • USDA loans. These loans are offered through a program with the U.S. Department of Agriculture. You may qualify for a USDA loan if you're planning to buy a home in an eligible rural area and have low to moderate income. There is no down payment requirement, and you may qualify with a 580 credit score, or lower in some circumstances. These loans, however, have an upfront guarantee fee and an annual fee, which doesn't go away. Consider this loan program if you're planning on moving to an eligible rural area and you meet the agency's income guidelines.

There are also some state government-backed mortgage programs, says Brian Koss, executive vice president of mortgage banker Mortgage Network. "Each state has its own state housing finance agency, and each state is very different in how they approach these loans," he adds.

Interest-only loans. With this type of loan, you're scheduled to pay only interest for a set amount of time – typically between three and 10 years. Once that period ends, you can pay off the loan with a large balloon payment, refinance the loan or start making regular principal-and-interest payments for the remainder of the loan term.

An interest-only loan may be appealing if you're on a budget, but unless you can afford a balloon payment or significantly higher payments after the initial period, it may not be worth it. It may be worth it, however, if you're only planning on staying in the home for a short period or you're confident you can afford the balloon payment.

Piggyback loans. piggyback mortgage makes it possible to avoid private mortgage insurance on a conventional mortgage without actually putting down 20%. For example, 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 remainder with a mortgage.

The drawbacks of this loan type are that refinancing separate loans in the future can be difficult and that the second loan may have a variable interest rate, which can go up over time.

Consider using a piggyback loan if the cost of the second mortgage is less than what you'd pay in private mortgage insurance and you're not planning on refinancing in the near future.

How to Decide Which Loan Is Right For You

Knowing which loan option provides the best fit can be challenging. Here are some tips to help you decide.

Compare multiple lenders and loan options. Mortgages are a major commitment, so don't rush this decision. Research at least a few lenders and get quotes for different loan types you may qualify for. It helps to get the bottom-line numbers on how much you'll pay in interest and fees over the course of your loan, along with your monthly payment.

Find a good loan officer or broker. A loan officer or mortgage broker can help you shop around. Not all mortgage professionals offer the same level of service, and you may need to shop around to find one who's willing to ask the right questions and make sure you get the right loan for your situation.

"With a good banker or broker, when you ask them a question, the first thing they should do is say, 'Tell me more about yourself first, so I can figure out what the right answers might be,'" Bechtel says. "If they don't ask any questions, then you've got the wrong person."

Not all lenders offer every type of mortgage. So if you're working with a loan officer from a specific lender, your options may be limited. In this situation, it may be worth talking with a broker who can work with multiple lenders to find the right fit.

Consider the pros and cons. There are many types of home loans because there are many types of homebuyers. As you consider different loan options, look at the potential benefits and drawbacks of each and how they apply to your specific situation.

With any conventional loan, for example, you may be required to pay private mortgage insurance if your down payment is less than 20%. But you can have the insurance requirement removed once you have that much equity in your home. With some government-insured loans, you may be able to qualify with a lower credit score or down payment, but it might be harder to get rid of the mortgage insurance, making it potentially more expensive over time.

Understand it's not always clear-cut. While different types of home loans have general criteria, lenders are empowered to make their own decisions about eligibility and loan terms. For example, a lender's credit score requirement for an FHA loan could be higher than 580.

Avoid getting a mortgage you can't afford. Some home loans make it easier to afford your monthly payment in the beginning and, potentially, increase their costs over time. In this situation, you might consider getting such a loan with the plan to refinance before the higher costs hit. But Koss says to think carefully before proceeding on this path.

"What if, in a year from now, your hours are cut and you don't get overtime anymore? What if you lose your job or someone messes with your credit?" he asks. "Everyone makes a decision assuming everything stays the same, but as we know, that never happens in life."

So if you're considering a loan with cheaper payments up front, make sure you can afford potentially higher payments down the road before you move forward.

Source: To view the original article click here

Posted by Jackie A. Graves, President on December 16th, 2019 8:02 AM

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