Understanding Your Mortgage Options

The variety of mortgage products available today helps you choose one that fits your budget, lifestyle, and future plans.

There is plenty to be excited about when you’re buying a house. There are also important decisions to make, and choosing the right mortgage for your new home is one of them. It can seem overwhelming, but by understanding the various types of loans, you can find one that meets your current needs while helping you plan for the future.

Learn about the different types of mortgage loans

Many different mortgage loans have evolved over time to give prospective homeowners choices and flexibility. This variety makes it possible for people with little or no down payment funds, or those with less-than-perfect credit, to buy a house. Here’s a quick look at some of the most common types of mortgage loans available:

• Conventional mortgages — In simple terms, a conventional mortgage is one that is not insured or guaranteed by the federal government. While the qualification requirements vary slightly between different conventional mortgages, in most cases you’ll need a credit score of 620 or higher and a debt-to-income ratio of 43% or less. Typically for a conventional mortgage, a down payment of at least 20% may help you avoid an additional monthly charge for private mortgage insurance, but many lenders now offer conventional options for smaller down payments.
• FHA mortgages — These loans are backed by the Federal Housing Administration, and have more lenient qualification requirements than conventional loans. Some lenders may approve you with a lower credit score. The size of your down payment is also important with an FHA mortgage. By making a down payment of at least 10% of the purchase price, you can decrease the upfront mortgage insurance premium, and also have the option for the monthly insurance fee to be removed after a certain amount of time. Over the life of the loan, this could save you thousands of dollars.
• VA loans — These loans are available only to military veterans, active duty military members and their surviving spouses. VA loans are fairly similar to conventional loans, but some of the qualification requirements are relaxed. You don’t have to make a down payment on a VA loan, although you can. And even if you make no down payment or a very small one, you won’t have to pay mortgage insurance. However, most VA loan borrowers will have to pay a funding fee, which is usually between 1.5 and 3.3 percent of the loan amount.
• USDA loans — If you’re buying a home in a rural area, USDA loans can be an attractive option because they’re often more affordable than other mortgage options. The home must be in a qualifying rural area as defined by the federal government, and these loans have income limits based on the area you’re buying in. Generally, the income limit accounts for everyone who will be living in the home. USDA loans also require a guarantee fee, which is similar to but generally lower than mortgage insurance.

Decide on the length of your mortgage term

Most mortgages give you the option of paying off your loan in 15 years or 30 years. The basic math is pretty simple. With a 15-year mortgage, your monthly payment will likely be higher but you’ll own your home outright in half the time. In contrast, a 30-year mortgage may keep your monthly payment lower, but you’ll make that payment over a longer period of time. The best choice for you depends on your circumstances, finances, and future goals:

• 15-year mortgage: The most obvious reason for choosing a 15-year mortgage is the amount of interest you would save compared to a 30-year mortgage. This is because you are making payments over less time. At the end of 15 years, you own your home and your payments stop. You build equity faster, which can give you access to cash for home improvements, education, or healthcare costs. But a higher monthly payment can put a strain on your budget if your income or financial situation changes.
• 30-year mortgage: With a lower mortgage payment, you might have more opportunity to save for retirement, college funds, or other expenses. You also have flexibility for the fluctuating budgets most families experience over time, such as higher utility bills at certain times of the year or unexpected costs like replacing a hot water heater or other appliances. You might also be able to afford a larger, more expensive home with a 30-year mortgage, because you’ll have longer to pay off the entire amount.

Some mortgages have a penalty for paying off the entire amount of the loan sooner than the term length, but others don’t. Shop for mortgages that don’t have this penalty, then try to pay extra during the months your budget allows for it. Over time, the extra amount can add up and take months or even years off the length of your mortgage, saving you money in the long run.

Fixed or adjustable rate mortgage?

With a fixed rate mortgage, the interest rate you pay is determined when you buy your home and never fluctuates. This builds a level of predictability into your budget, you can be sure the amount of your monthly mortgage payment will never change.

An adjustable rate mortgage, or ARM, will generally start with a fixed rate for the first 5 or 7 years of the loan. After that, your interest rate (and your monthly payment) will rise or fall based on current rates and other factors, such as your credit score and credit history. Most ARMs have a cap which limits the amount your rate can rise at each readjustment, and a cap which limits the total amount your rate can rise over the life of the loan.

The right rate choice depends on your level of comfort with the possibility your mortgage payment could rise in the future, along with other factors. Because interest rates are generally low right now, the fixed rate option is popular with many homebuyers. But if there’s a good chance you’ll move out of your home and sell it before the fixed rate period ends, an ARM might be appealing to you.

You have choices

Buying a house is a very individual experience, and the right mortgage depends on your unique circumstances. Fortunately, there are different types of mortgages, term lengths, and interest rates to make homeownership affordable. By asking questions and understanding your options, you can choose a mortgage that will be affordable, help you build equity, and give you peace of mind so you can enjoy your new home.