When looking to purchase a home, it’s essential to determine which type of mortgage works best for your situation. There are various mortgage types and each offers its own advantages.
An adjustable rate mortgage (ARM) offers an introductory interest rate that is fixed for a specified period. After that, the ARM’s interest rate can change periodically according to an index.
Fixed Rate Mortgages
Fixed rate mortgages are the most sought-after home loan, providing borrowers with stability to plan for their long-term financial objectives. They are available from many lenders such as banks, credit unions, mortgage lenders and even FHA and VA loans.
One major advantage of fixed rate mortgages is their consistency throughout the life of your loan. Your monthly payment will always include principal, interest and any fees charged by your lender – such as property taxes, homeowners insurance or private mortgage insurance.
Another advantage of fixed rate mortgages is they typically come with lower closing costs than adjustable rate mortgages (ARMs). However, borrowers should weigh the advantages of a fixed-rate loan against the cost of higher monthly payments to make an informed decision when shopping for a mortgage.
Term lengths differ between lenders, but a 15- or 30-year mortgage is the most popular choice. The shorter your mortgage term, the lower your monthly payments will be; however, you should take into account how much you can afford to pay each month and how quickly you wish to repay the loan.
Some lenders even provide long-term fixed rates, up to 40 years. Although this may sound attractive, you should carefully weigh the risks involved with such long commitments since if you want to break the deal early, usually there will be a fee involved.
Fixed-rate mortgages can be difficult to qualify for, but they offer financial security and peace of mind to borrowers who value financial security and peace of mind over other loan types. Furthermore, fixed rate mortgages tend to be cheaper in the long run compared to ARMs; as such, they could be ideal options for first-time home buyers or those looking to upgrade from a smaller property into something larger.
Adjustable Rate Mortgages
Adjustable rate mortgages (ARMs) are home loans with a variable interest rate that changes periodically. They’re popular among borrowers seeking lower initial interest rates and cheaper monthly payments, but they come with risks as well.
One of the primary drawbacks to ARMs is that they lack predictability. After an initial fixed period, interest rates can change according to market conditions, leading to drastic adjustments in your mortgage payments if you’re unprepared. This type of scenario should be taken seriously by any homeowner with little financial cushion.
Fortunately, there are ways you can protect yourself against these worst-case scenarios. One such step is selecting an adjustable-rate mortgage (ARM) with a cap, which limits how much the rate can increase each time it adjusts and how much total amount changes over the loan’s lifespan.
For example, you can select a three or five year ARM that starts out with a fixed rate for the first few years and adjusts according to market index changes. Or you could go with an interest-only ARM, in which you pay only interest on your loan for a set period before beginning principal and interest payments again.
Another option is a hybrid ARM, which begins with a fixed interest rate for the first few years and then adjusts according to an adjustable schedule set by your lender. This type of ARM typically links to a money market index that fluctuates based on that index’ performance.
The primary advantage of ARMs is that they often offer lower initial rates than fixed-rate mortgages do. While this makes ARMs appealing to borrowers who want to maximize their savings by paying down the loan quickly, keep in mind that your initial low rate may result in substantial increases to your payments once it adjusts.
If you’re thinking about taking out an ARM, consult a financial expert and get an estimated monthly payment amount. Then, compare those figures with your existing budget to see if these changes are feasible within your existing spending limits.
Jumbo Loans
Jumbo loans refer to mortgages that exceed the conforming loan limits set by Fannie Mae and Freddie Mac, which vary state by state but typically range from $647,200 or more.
Non-conforming loans, offered by private lenders, can be used for financing primary residences, vacation homes, investment properties and more. Since these mortgages aren’t guaranteed by government-backed giants like traditional ones, they often carry higher interest rates than their traditional counterparts.
Jumbo loans may be more challenging to qualify for than conventional loans, but the rewards can be worth the extra effort. Most notably, they enable borrowers to purchase high-value properties that would otherwise be impossible without a jumbo loan.
Jumbo loans typically provide lower interest rates than conventional ones, though they require a larger down payment and credit score to secure. Jumbo loans therefore tend to have more restrictions than standard mortgages due to their greater risk factor for banks.
Jumbo loans are frequently the go-to choice for major property purchases, such as luxury homes or those located in high-cost housing markets. Furthermore, these loans can be beneficial if borrowers plan to rent out or use their new residence for business purposes.
Jumbo loans offer investors the potential for growth. Unfortunately, they’re more challenging to obtain than conventional mortgages for those looking to purchase a house as their own personal residence.
Additionally, lenders may require an additional appraisal of a home to verify its worth for the amount being borrowed. This is because banks don’t want to lend more money than what the property is actually worth and so need assurance that borrowers are capable of making payments.
Furthermore, many jumbo loans require the borrower to secure an additional 12 months of cash reserves in order to cover potential mortgage payments. This serves as insurance for the lender in case something unexpected should happen to their income or financial situation.
FHA Loans
FHA loans can be an ideal solution for those with credit challenges or limited cash reserves to put towards a down payment. Since these loans are guaranteed by the government, lenders may feel more confident providing financing to borrowers who might otherwise present too much risk on conventional mortgages.
They require lower credit scores than conventional loans and offer down payments as low as 3.5%. It’s important to remember that these lower minimums are only guidelines – individual lenders may have their own higher requirements.
Another advantage of an FHA loan is that borrowers don’t need to worry about the hefty upfront insurance fee associated with other types of mortgages. This coverage, known as mortgage insurance premiums (MIP), is included in their monthly payment.
Insurance is designed to safeguard lenders against losses if the borrower defaults on their loan. Unfortunately, it comes at a cost which varies based on the size of your down payment and mortgage balance.
The annual mortgage insurance premium, which can be paid monthly or in one lump sum at closing, ranges between 0.45% – 1.05% of the base loan amount and remains for as long as you own the loan. You’ll pay this fee in addition to your regular monthly payments which may be higher with an FHA loan than with a conventional mortgage.
Before making a decision to purchase a home, it’s wise to compare your options. Be sure to understand the pros and cons of each type of loan.
A high credit score and a small down payment are the two primary factors in determining which mortgage type is right for you. Be sure to shop around to find a lender willing to work with your credit history.
You should also take into account your debt-to-income ratio (DTI). This is the percentage of your monthly income that goes toward paying off debts such as your mortgage, auto or student loans and credit cards.
Generally, a lower debt-to-income ratio (DTI) is better for your chances of approval for an FHA mortgage. Therefore, try to eliminate any debt that takes up more than 41 percent of your gross income.
