If you’re looking to buy a home, get in line. Homes are at a premium across the US, and it has been a seller’s market for several years. However, if you can make a competitive offer and move quickly, interest rates remain low, so getting into the market now while rates are low is a smart financial move.
If you want to buy your first home or invest in real estate and want to finance your purchase with a mortgage, you’ll need to understand all of your different mortgage options. There are many factors to consider, such as your credit score, the amount of debt you have, how long you’ll own the home, the down payment, whether you qualify for any government-backed loans, and whether the home will be your primary residence or a rental property.
This article will help break down the different types of mortgages that are available. Read on to learn more about how to finance your home purchase.
Conventional loans are the most common type of mortgage loan. The loan is not backed by the federal government (like some of the other loans in this list) but instead is backed by a private lender, such as a bank, credit union, or mortgage company.
Conventional loans are popular for a reason: they typically have low interest rates, and your payment remains the same throughout the life of the mortgage.
There are two types of convention loans: conforming loans and non-conforming loans. The amount of the loan determines which type it is. Conforming loans are less than $548,250 in most counties, and non-conforming loans are over this amount (typically called jumbo loans and are discussed in more detail below).
If your down payment is less than 20% of the home’s value, you will have to pay something called private mortgage insurance (PMI). This protects the lender if something should happen to your home before paying off 20% of the loan. The amount of your PMI depends on the price of the home and how much you are putting down.
Once you reach 79%, you can ask your lender to remove the PMI from your monthly payment.
You can choose a 15-year or 30-year mortgage with a conventional loan. Your interest rate will typically be lower with a 15-year loan, but your payment will be higher since you are only spreading payments out over 15 years and not 30. However, if you can afford a 15-year mortgage, you will save yourself thousands of dollars in interest.
Conventional mortgages have a fixed rate, meaning that the interest rate remains the same throughout the life of the loan. The only time your interest rate may change is if you refinance your home.
Conventional loans are best for people with good credit scores (typically 620 or higher), have a down payment saved, have a debt-to-income (DTI) ratio that is no more than 45-50%, and have adequate records to document income, debt payments, and other relevant financial information.
Jumbo loans are a type of non-conforming conventional loan. If you are buying a home worth more than $548,250, you may need a jumbo loan. To qualify for this loan, you must have good to excellent credit and a significant amount of money available for a down payment.
Because the loan amounts for jumbo loans are so high, lenders require good credit scores, low debt, and sizable down payments. Because of the size of the loan, the federal government won’t purchase it or guarantee it, which means that you won’t get the best interest rates, as those are reserved for smaller loans that are often sold to Fannie Mae or Freddie Mac, the two federal mortgage companies.
Unlike conventional or jumbo mortgages, FHA loans are backed by the federal government. This means that you will get the best interest rates available.
FHA, or Federal Housing Authority, loans are meant to make homeownership within reach for those who may not save a large down payment or who don’t have great credit. FHA loans are a good option for first-time homebuyers.
There are some requirements, though, for FHA loans. The home you are buying must be your primary residence, cannot be a vacation or second home, and cannot be a condo.
The larger your down payment, the lower your credit score can be to get approved. You must also have a DTI less than 43% to qualify, and you’ll need to pay PMI. Unlike a conventional loan where you pay your PMI monthly as part of your mortgage payment, FHA loans require you to pay PMI upfront each year.
FHA loans can be a good option for you, but they also often end up being more costly over the life of the loan. Make sure you fully understand what you are getting into if you take out an FHA loan.
USDA loans are also backed by the federal government; in this case, the United States Department of Agriculture backs these loans to help low-income borrowers purchase a home. They are also meant to help develop suburban or rural areas.
USDA loans are cheaper than FHA loans, as there are fewer fees. You also do not need a down payment on most properties, and you can get a loan for home improvements as well.
While you don’t need a down payment, you must meet income requirements, and your property value must not exceed a certain amount.
VA loans are another government-backed mortgage. They are backed by the Department of Veterans Affairs, and you can only qualify for a VA loan if you are a current service member or a military veteran. The interest rates are low, and you do not need a down payment for a VA loan.
There is no minimum credit score required, and you do not have to pay PMI. There is an upfront funding fee that you must pay, though.
The funding fee is meant to offset the cost of a VA loan to taxpayers since you do not have to put any money down. The fee varies depending on whether it’s your first VA loan or not and how much money you are putting down.
The fee may change yearly and is a percentage of your loan amount. You can pay the fee in full upfront or roll it into your loan and pay it over time.
Interest-Rate Only Mortgages
Interest-rate only mortgages are just that: you pay only the interest and don’t pay down the principal. For example, if your monthly payment is $1500 and $1000 of that is interest, you pay only $1000 a month. This allows you a lower monthly payment if you need financial assistance.
The first few years of your mortgage payments primarily go towards insurance, so this is an option for a few years if you are in a tight financial spot. Your lender will specify the interest rate only period, and it is up to you to make any payments towards the principal during this time if you wish.
If you plan to only be in your home for a short time, this may be a good option. You will need to show substantial assets and an ability to pay to qualify for this type of loan.
If you expect your income to rise or you have a fluctuating income, you can use an interest rate only to mortgage to have a smaller payment and then use influxes of cash to pay down your principal. You must be disciplined enough to make these voluntary payments towards the principal, so this loan may not work for everyone.
Adjustable-rate mortgages, or ARMs, are the opposite of conventional or fixed-rate mortgages. Instead of having the same interest rate throughout the life of the loan, and ARM has a fixed rate for a few years at the beginning of the loan, and then the interest rate varies based on market conditions.
A common type of ARM is a 5/1, 7/1, or 10/1, where you have a fixed rate for the first 5, 7, or 10 years of the mortgage, and then your rate will vary. The introductory interest rate is typically lower than the current market rate. Once that introductory period is up, your interest rate may vary yearly based on the market and what current interest rates are.
ARMs typically have rate caps, limiting how high your interest rate can change in a certain period and over the life of your loan. This protects you as the borrower as you know that your rate will never exceed a certain percentage, and it protects you from interest rates rising dramatically in a short period of time.
Once you hit that cap, your interest rate cannot go any higher, even if market rates continue to increase. There also may be a lower limit that your interest rate may not go lower than.
If you will only be in your home for a few years and will sell before your introductory period ends, these can be a good choice for you as the payment will likely be lower than if you took out a conventional mortgage.
You can also use the introductory period to put extra money towards the principal. The more you pay on the principal, the shorter your loan term, and the less you pay in interest.
Take advantage of that low-interest rate by putting any extra income you have directly towards the principal amount of your loan. You might be shocked at how much you can save in interest by doing this.
Balloon mortgages are less common than the others discussed here but are another option if you are only going to be in your home for a short period of time or if you expect home values to rise dramatically.
In a balloon mortgage, you pay interest only for a set period of time, usually 7 or 10 years. At the end of this period, you owe a lump sum (the “balloon”). The monthly payments tend to be similar to a normal 30-year conventional loan, and then the balloon payment will pay off the loan balance.
If you flip homes, for example, and make a large profit selling the home, you could do a balloon mortgage. Or, if home values are rising, you can sell before that balloon payment is due and use that profit to pay off the loan balance.
These loans are not right for everyone, though, as that balloon payment may be unmanageable, and the housing market could change drastically in a way that you don’t expect.
Bridge loans are one option if you are purchasing an investment property. These loans allow you to quickly purchase rental properties and get the funds to improve them. The interest rate is often higher on these loans, but they are meant to be short-term solutions.
You will often need to go to a private lender, like LendSimpli, to get a bridge loan.
Which Type of Mortgage Is Best for You?
Getting a mortgage can often be an overwhelming process, especially if you are buying the property as an investment. It can be confusing to determine which type of mortgage is best, depending on your financial situation, what you plan to do with the home, and the market conditions.
An experienced mortgage lender can help you understand the options and advise you on what type of mortgage is the best for your situation and investment plans. Contact LendSimpli today to speak to a mortgage broker about your options and start your application online. We lend to real estate investors and offer competitive rates and make the process quick and simple.