When buying your first home, navigating the world of financing options can be somewhat daunting. In addition to the options available, consider your own finances to ensure that you are getting the mortgage that best suits your needs. Here's a look at several mortgage loan types:
Conventional Loans
Conventional loans are fixed-rate mortgages that are not insured or guaranteed by the federal government. The good thing about these is that the interest rate is fixed, so your payments won't fluctuate. They can, however, be the most difficult type of mortgage to qualify for due to their requirements for the amount of your down payment, income, and credit score. Some costs like private mortgage insurance can be lower than with other guaranteed mortgages.
Conventional loans are classified as either conforming loans or non-conforming loans. Conforming loans follow the guidelines set by Fannie Mae and Freddie Mac for things like loan limits since they package these loans and sell securities on them in the secondary market.
FHA Loans
FHA stands for Federal Housing Administration and is part of the U.S. Department of Housing and Urban Development (HUD). FHA loans have lower down payment requirements and are easier to qualify for than a conventional loan. Many first-time homebuyers take advantage of FHA loans since there are lower up-front loan costs and less stringent credit requirements. FHA loans allow down payments of as low as 3 percent and have a statutory limit on the amount of the loan.
VA Loans
VA stands for the U.S. Department of Veterans Affairs. The VA guarantees VA loans which means they don't make loans directly, but guarantee the mortgages made by qualified lenders. The guarantees allow veterans and service people to get favorable terms on a mortgage loan, often with no down payment and easier qualification standards than conventional loans. Lenders often limit the maximum VA loan amount. Before applying for a loan, you'll need to request eligibility from the VA. Upon acceptance, you'll receive a certificate of eligibility to be used when applying for a VA loan.
Fixed Rate Loans
You'll want to decide whether a fixed-rate or floating-rate (such as an adjustable-rate or interest-only) mortgage is going to best meet your needs. A fixed-rate mortgage is just that -- the interest rate does not change for the entire period of the loan. You'll know exactly what your monthly loan payments will be for the life of the loan. Floating rate loans are designed to assist people who expect that their incomes will rise over the loan period, so they will be able to make larger loan payments during the loan period.
Floating Rate Loans
Floating rate loans usually offer a lower introductory rate during the first few years of the loan, making them especially appealing to first-time home buyers and allowing you to qualify for a larger loan than if you applied for a fixed-rate loan. While attractive, there is substantial risk to borrowers whose income does not increase along with the change in interest rate. You often don't know what the rate change will be when first embarking on this type of loan since it is usually tied to a market rate that is determined in the future.
Adjustable Rate Mortgage Loans
Adjustable Rate Mortgages, or ARMs, often come in three types: one, five, or seven year ARMs. The initial rate is set for a period of time and then it is reset periodically, often each month. When the rate resets, it adjusts to the current market rate, usually by adding a percentage to the prevailing Treasury rate. There is usually a cap to limit the increase by contract, yet the risk is when an ARM adjusts, it could end up with a rate that's higher than the prevailing fixed rate mortgage loan.
Interest Only Loans
Interest Only loans are a kind of ARM whereby you are responsible for only paying mortgage interest and not principal during the introductory period until the loan reverts to a fixed, principal-paying loan. First-time homebuyers are often attracted to this type of loan since your monthly loan cost is significantly lower while only paying the interest and you may qualify for a larger loan amount. Since you are paying interest only and not principal during the initial period, the balance due on the loan does not change until you begin to repay the principal.
It's important when deciding on a mortgage for your first home that you consider how much you can actually afford and then finance accordingly. Your trusted loan officer or mortgage broker should be able to help steer you through all the different options available.