Buying a home is an incredibly exciting step in our lives! Whether it’s your first home, your forever home or an investment property, it is a big move and investment for any one of us. But it can also be daunting. In most circumstances, we are talking about taking on an incredible amount of debt in one single swoop.
Because of that, you want to make sure you fully understand your options and decide on the type of mortgage that makes the most sense for you!
So let’s breakdown each different type of mortgage and why an individual would opt for one option vs. another.
These loans are the most popular options for homeowners today.
These loans are not backed by the US government and typically have lender specific criteria to qualify for a mortgage. For example, in most circumstances, you must have a credit score of at least 620 to qualify for a conventional loan. There are down payment minimums and you may also need to take property specific guidelines and income restrictions into account when applying for a loan. Below are a few types of conventional loans:
With both the 30 year and 15 year, you will pay a fixed interest rate for the life of the loan.
The 30 year fixed rate mortgage is the most common type of mortgage available to consumers. Due to the length of the loan, your monthly payment will be less, leaving you with some flexibility if you would like to pay any additional principal, you can. Or you can use your cash flow for other priorities.
Pros: Flexibility, predictability, lower monthly payments
Who is it best for: For those individuals who anticipate being in the home long term, have a need for lower monthly payments or want to lock in a low interest rate and use their additional cash flow for other priorities.
The 15 year fixed rate mortgage will offer a lower interest rate, but due to the reduction in the life of the loan, your monthly payments will be greater.
Pros: Typically offers lower interest rates and less overall interest paid over the life of the loan in comparison to a 30 year fixed rate mortgage.
Who is it best for: Good for those who want to build equity in the home as quickly as possible and have the means and cash flow to support the higher monthly payment.
An adjustable rate mortgage (ARM) will lock in an interest rate for a specified number of years depending on the loan. Often times they are offered at 5, 7 and 10 year intervals. The life of the overall ARM loan will typically be 30 years.
For example: a 5/1 ARM would offer a fixed interest rate for 5 years and then after that point, the interest rate would fluctuate with that of the market on an annual basis until the end of the loan period.
Interest rates on these ARM loans are typically lower at first, with lower payments, but you have to manage the uncertainty around where interest rates will go after that fixed period ends.
Pros: Interest rates will typically be lower during that specified fixed period then many other loan options which will lend itself to lower monthly payments.
Who is it best for: This option would be good for someone who is anticipating that interest rates will be lower in the future (I would not play this game!) or for someone who will either be refinancing the home or moving/selling the property before the fixed rate term ends.
Interest only mortgages are exactly as they sound. You pay interest payments only on the house for the specified term and then your principal payments will start kicking in after that set time period for the remainder of the loan (typically 30 years).
Interest only mortgages will typically be for 5, 10, and 15 year terms. For example: a 10 Year I/O mortgage would require you to pay interest only, at the stated fixed interest rate, for 10 years. After the 10 years, your payment would then increase to include your principal and interest payments going forward.
Pros: Competitive interest rates, with lower monthly payments and significant mortgage interest deduction in the years of interest only payments.
Who is it best for: These mortgages are good for those who do not believe they will be in the house long term, are not interested in building equity in the home and believe the home value will be increasing in a short period of time.
Non conforming loans are those that are backed by the US government. They often times have more flexibility as well. For example they may have lower credit limit or down payment requirements and may allow for higher debt to income allowances. See a few examples of non conforming loans below:
Federal Housing Administration (FHA) loan is one that is insured by the FHA and backed by the US Government in an effort to provide opportunity and housing options for more modest income earners.
These FHA loans will often allow down payments as low as 3.5% and their credit score requirements will be more flexible than conventional loans.
Mortgage insurance premiums are required under an FHA loan.
Pros: Credit score requirements are often times lower than conventional loans and they have significantly lower down payment requirements. The interest rates tend to be lower than similar term conventional loans as well.
Who is it best for: Those who have lower credit scores and do not have a significant down payment available for a conventional loan.
A VA loan is one that is backed and secured by the Department of Veterans Affairs and are available to military service members and veterans.
There are no down payment requirements and often times very low interest rates accompanied with the loan. You will be responsible for paying VA funding fees which will run anywhere between 1.5% -3.5% of the loan.
Pros: No down payment requirements, competitive interest rates and no private mortgage insurance.
Who is it best for: For military service men and women who qualify and want to take advantage of very competitive interest rates and no down payment requirements.
USDA loans are back and secured by the Department of Agriculture. They are available to those who meet certain income requirements and to those who live in eligible rural areas as determined by the USDA.
There are no down payment requirements and often times are accompanied with lower interest rates available.
Pros: No down payment requirements
Who is it best for: For those who can’t put money down, are in a low-to-moderate income range and want to purchase a home in a rural area, a USDA loan might be best.
Hope you found this summary helpful as you navigate which mortgage offering is best for you and/or your family!
Read my blog post on A Letter to the First Time Home Buyer to learn more about the costs associated with home ownership!
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