When you are first getting into real estate majority of the process can seem overwhelming. Thus it is key to have well educated and informed professionals in your corner to simplify and thoroughly explain all aspects. In this blog post I would like to cover the 6 most common home loans: fixed-rate mortgage loan, adjustable-rate mortgage loan, conventional loan, FHA and VA.
1. Fixed-rate Mortgage Loan
A fixed-rate mortgage has an interest rate that remains the same for the life of the loan. In other words, your total monthly payment of principal and interest will remain the same over time.
Note: Your mortgage payments can fluctuate, though, if your property taxes or homeowners insurance rates fluctuate.
A fixed-rate mortgage is the most popular type of financing because it offers predictability and stability for your budget.
Fixed-rate mortgages tend to have a higher interest rate than an adjustable-rate mortgage.
How long did I repay a fixed-rate mortgage loan?
Fixed-rate mortgages usually come in terms of 15 or 30 years.
Here are some pros and cons of each term:
- For any given loan amount, the monthly payments are lower than a shorter-term mortgage.
- You pay more total interest over the life of the loan compared with a shorter term.
- The interest rate is higher.
- You pay less total interest over the life of the loan.
- The interest rate is lower.
- For a given loan amount, the monthly payments are higher.
Many borrowers prefer a 30-year, fixed-rate mortgage over a 15-year loan because the monthly payment is lower for the same loan amount. Choosing a longer fixed term means you can borrow more money, too. It can also free up your monthly cash flow for other financial goals, such as saving for emergencies, retirement or your child’s college tuition.
2. Adjustable-rate Mortgage Loan (ARM)
With adjustable-rate mortgage loans (ARMs), the rate will fluctuate—moving both up and down—based on market interest rates. There is also a hybrid option, where the loan has a fixed rate for a specific amount of time, and then, beyond that, the rate adjusts annually.
For example, the 5/1 ARM has a five-year fixed rate and then, after five years, the loan adjusts each year.
ARMs typically start off with a lower rate so they can be appealing, specifically for first-time home buyers or buyers on a strict budget. However, because rates rise over time, home owners could find themselves unable to pay later.
“ARMs can make sense for customers who know they will be relocating in the near future or they know they will be paying off the loan in a few years.”
The pros of an of adjustable-rate mortgage
- Low payments in the fixed-rate phase
- A hybrid ARM offers potential savings in the initial, fixed-rate period. Common ARM terms are 3/1, 5/1, 7/1 and 10/1. With a 5/1 ARM, for example, your introductory interest rate is locked in for five years before it can change. That gives you five years of predictable, low payments.
- An ARM can be a good idea if your life is likely to change in the next few years — for instance, if you plan to move or sell the house. You can enjoy the ARM’s fixed-rate period and sell before it ends and the less-predictable adjustable phase starts.
- Rate and payment caps
- ARMs may have several types of caps, which limit the increases on your mortgage rate and the size of your payment. These include caps on how much the rate can change each time it adjusts and the total rate change over the loan’s lifetime.
- Your payments could decrease
- If interest rates fall, and drive down the index against which your ARM is benchmarked, there’s a possibility that your monthly payment could drop
The cons of an adjustable-rate mortgage
- Your payments could increase
- If interest rates are rising, your payments could increase after the adjustable period begins; some borrowers might have trouble making the larger payments.
- Things don’t go as planned
- ARMs require borrowers to plan for when the interest rate starts changing and monthly payments may grow. Even with careful planning, though, you might be unable to sell or refinance when you want to. If you can’t make the payments after the fixed-rate phase of the loan, you could lose the home.
- Prepayment penalty
- Some ARMs come with a prepayment penalty. This is a fee that can be charged if you sell or refinance the loan. If you plan on selling the home or refinancing within the first five years of the mortgage, you should choose a lender who offers a loan without this penalty.
- ARMs are complex
- ARMs can have complicated rules, fees and structures. These complexities can pose risks for borrowers who don’t fully understand what they’re getting into.
3. Conventional Loan
About half of all conventional loans are called “conforming” mortgages, because they conform to guidelines established by Fannie Mae and Freddie Mac. These two government-sponsored enterprises (GSEs) buy mortgages from lenders and sell them to investors. Their purpose is to make mortgages more widely available. All conforming mortgages are also conventional mortgages.
Loans that do not conform to GSE guidelines are referred to as “non-conforming” home loans. Non-conforming loans that are larger than loan limits set by the GSEs are often referred to as “jumbo” mortgages. All non-conforming mortgages are also conventional mortgages.
Conventional loans held by mortgage lenders on their own books are called “portfolio” loans. Because lenders can set their own guidelines for these loans and do not sell them to investors, these products may have features that other mortgages do not.
For example, a portfolio lender might allow a borrower to use investments like stocks and bonds as security for a mortgage for which she would not otherwise qualify.
Conventional home loans marketed to borrowers with low credit scores are called sub-prime mortgages. They typically come with high interest rates and fees. The government has created special rules covering the sale of such products, but they are not government-backed — they are conventional loans.
4. Federal Housing Administration (FHA) Loan
An FHA loan is a government-backed mortgage insured by the Federal Housing Administration, or FHA. Popular with first-time home buyers, FHA home loans require lower minimum credit scores and down payments than many conventional loans. You can qualify for an FHA loan with a credit score as low as 500 with 10 percent down. To get FHA’s maximum financing, you need a credit score of 580 or higher and 3.5 percent down.
FHA borrowers also pay for mortgage insurance, which protects the lender from a loss if the borrower defaults on the loan.
Is an FHA loan right for you?
An FHA loan can be an excellent choice for a new home buyer or someone with a spotty credit history that is ready to buy a primary residence house. With its low down payment requirement, an FHA loan can be affordable if you don’t have a lot of money upfront.
Also, home buyers will want to consider whether the cost of monthly FHA mortgage insurance (which is typically higher than PMI) is financially feasible in the long term. On a conventional mortgage, PMI may be dropped after the borrowers build 20 percent equity in the home, but FHA loans can carry the mortgage insurance fee through the life of the loan. Switching to a conventional mortgage once you’ve built up equity is an option, but making the change will require more money in closing fees.
Regardless of which type of loan you choose, all borrowers should think through how much they can afford and how a home loan will impact their monthly budget and financial future. If an FHA loan can help you buy a house and stay within a comfortable budget, it may be the right choice for you.
5. Veterans Affairs (VA) Loan
VA helps Service members, Veterans, and eligible surviving spouses become homeowners. As part of our mission to serve you, we provide a home loan guaranty benefit and other housing-related programs to help you buy, build, repair, retain, or adapt a home for your own personal occupancy.
Purchase Loans help you purchase a home at a competitive interest rate often without requiring a downpayment or private mortgage insurance. Cash Out Refinance loans allow you to take cash out of your home equity to take care of concerns like paying off debt, funding school, or making home improvements. Learn More
Interest Rate Reduction Refinance Loan (IRRRL): also called the Streamline Refinance Loan can help you obtain a lower interest rate by refinancing your existing VA loan. Learn More
Native American Direct Loan (NADL) Program: helps eligible Native American Veterans finance the purchase, construction, or improvement of homes on Federal Trust Land, or reduce the interest rate on a VA loan. Learn More
Adapted Housing Grants: help Veterans with a permanent and total service-connected disability purchase or build an adapted home or to modify an existing home to account for their disability. Learn More
Your length of service or service commitment, duty status and character of service determine your eligibility for specific home loan benefits.
Purchase Loans and Cash-Out Refinance: VA-guaranteed loans are available for homes for your occupancy or a spouse and/or dependent (for active duty service members). To be eligible, you must have satisfactory credit, sufficient income to meet the expected monthly obligations, and a valid Certificate of Eligibility (COE). Learn More
Interest Rate Reduction Refinance Loan (IRRRL): The IRRRL is a “VA to VA” loan, meaning it can only be done if you have an existing VA guaranteed loan on the property. The IRRRL is generally performed to lower the interest and reduce the monthly payment on the existing VA guaranteed loan. Learn More
Native American Direct Loan (NADL) Program: The NADL program helps Native American Veterans purchase, construct, improve, or re-finance a home on Native American trust lands. Your tribal organization must participate in the VA direct loan program. You must have a valid Certificate of Eligibility (COE). Learn More
Adapted Housing Grants: VA helps Veterans with certain total and permanent disabilities related to your military service obtain suitable housing with either a Specially Adapted Housing (SAH) or Special Housing Adaptation (SHA) grant. Learn More
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