Record-low interest rates and diverse lending options make finding the right home loan easier than ever. To get the best deal on the ideal home, learn how these popular mortgage types can impact your bottom line.
Fixed-rate mortgages continue to be the top choice for residential buyers. The ability to pay back the money over several decades, combined with enticing interest rates, attracts first-time homebuyers and people wanting to refinance existing contracts.
A fixed-rate home loan provides stable monthly payments for the life of the loan, making it an ideal solution for individuals budgeting over the long term. Applicants can choose to spread their payments over 10, 15, 20 or 30 years. A few banks even offer loans up to 40 years. The long loan period reduces monthly payment amounts but increases the overall cost of borrowing. Furthermore, these mortgages are front-loaded, so most of the initial payments go toward interest instead of principal. Fixed-rate mortgages typically benefit people who will be living in the home for seven years or more.
About one in ten residential mortgage customers takes advantage of a variable-rate mortgage, also known as an adjustable-rate mortgage or ARM. The most common ARMs start with a fixed interest rate for a certain period, usually one, three, five, seven or 10 years. The low initial rate can keep starter payments low and help borrowers afford more expensive houses and condominiums. Adjustable-rate mortgages are popular with people who plan to live in a home only a few years.
Unlike with a fixed mortgage, variable mortgage payments can change over the life of the loan. These changes may take place annually, quarterly or monthly. Lenders tie the loan’s interest rate to a published index plus a profit margin. Many contracts include a cap that limits how much the interest can increase during any particular adjustment period and over the life of the loan.
Under an interest-only mortgage, the borrower pays nothing toward principal for the first five to ten years. This structure reduces the initial monthly costs of the loan. After the interest period, the borrower must pay off the remaining balance or refinance that amount. Some lenders permit borrowers to end the contract by making interest and principal payments. These payments are higher than with other types of financing because the repayment period is shorter. For instance, a 30-year mortgage with seven years of interest-only payments leaves the borrower only 23 years to pay the balance. Interest-only mortgages can be helpful for young professionals planning to make significantly more money after graduation, someone receiving commissions or bonuses instead of regular paychecks, business owners with “fat” and “lean” months or someone putting the payment savings into investments with higher rates of return.
Jumbo loans are larger versions of ARMs, fixed-rate mortgages and interest-only products. These mortgages let people finance expensive homes that surpass the federal conforming loan limits. These limits start at $417,000 and can be higher in certain areas. Because banks take on more risk with these large mortgage amounts, they often require hefty down payments, high credit scores and low debt-to-income ratios.
Federal Mortgage Guarantees
Certain homebuyers can combine the advantages of fixed-rate or variable-rate mortgages with the financial backing of the United States. Under the FHA and VA loan programs, the federal government agrees to pay back a bank if the borrower defaults. This agreement helps to convince banks to approve applicants with small down payments, poor credit scores or high debt-to-income ratios.
- FHA loans, insured by the Federal Housing Administration, focus on owner-occupied primary residences. The borrower pays an upfront mortgage insurance premium plus a monthly insurance payment for the life of the loan. Interest rates and costs can vary between lenders.
- VA loans, backed by the Department of Veteran Affairs, are available only to active-duty military, veterans, reservists and members of the National Guard. These loans do not require any down payment. Borrowers must pay a one-time funding fee of between 2.5 and 3 percent, which can be added to the loan balance.
Overall, today’s home-buyers can qualify for mortgages to fit nearly any goal. By understanding their home loan options before talking to a lender, borrowers can stick to their budgets and still negotiate the best contracts.