The best mortgage type for you is one you can live with for as long as you live in the home. Conventional mortgages of either 15 or 30 years, adjustable rate mortgages, FHA loans, VA loans, and jumbo loans are the most common types of mortgages.
Determine How Much House You Can Afford
Before you think about the type of mortgage you need, you should figure out how much you can afford. Our mortgage calculator can help estimate the monthly payment for different loan types and interest rates. You may want to talk with a real estate agent or lender about your budget as well.
Understand the Total Cost of the Home
The total cost of a home is more than just the listing price. You might also need to pay for closing costs, the down payment, and moving expenses. These vary by state but can be between $1,100 - $29,000.
Related: A Complete Guide to Closing Costs
You will also have monthly mortgage payments, which should include interest and property taxes and homeowners insurance if you don't already own a policy.
In addition to these basics are other fees that come with buying your home, such as appraisal or inspection costs. Again, this varies depending on where you live, so it's important not to go into this blind.
How Financially Stable Are You?
It's essential to understand your financial stability before jumping into a mortgage commitment. If you aren't in a good place, it's best to wait until your income is higher before committing to this type of debt.
It could be difficult for some people who have more than one loan or are still paying off student loans, making them unable to afford the larger monthly payments associated with buying a home.
If you feel financially stable enough to buy a home and your job prospects seem secure, it's probably a good idea. But if things are shaky at work, you're unhappy in your job, or you don't feel secure financially, it might be best to wait a bit.
When Might You Move?
If you think you're going to move in a couple of years, it might make more sense to rent or look at an adjustable-rate mortgage. But if you're planning on staying in the home for the long term, a 30-year fixed mortgage might make a ton of sense for you.
Related: Should You Rent a Home or Buy One?
Plan to Save for Your Upfront Costs
There are several upfront costs you'll run into when buying a home: the down payment, your mortgage insurance premium, and taxes, to name a few of the big ones.
So it's helpful to establish a savings goal ahead of time to cover these upfront costs.
For example, if you plan to put 20% down on the home and you have a $250,000 purchase price, that means your upfront costs will be at least $50,000.
There's an easy way to figure out what you can afford: the 28% rule of thumb.
It says that your monthly housing expenses should total no more than 28% of your gross monthly income. So, for example, if your gross monthly income is $5,000 a month, you'll want to total the mortgage, property taxes, and PMI (private mortgage insurance) of the house you want. Your monthly mortgage payment should total less than $1400 a month using this formula.
Choose the Right Mortgage Term
Most people buy homes by paying with a mortgage. There are different lengths of time you can have the mortgage.
Some people choose to pay more interest and get a 30-year loan, while others would rather have a 15-year loan with higher payments but pay less interest.
You can also get shorter and longer terms than that; it just depends on what your lender is offering. The goal here, though, is to choose the mortgage term that will be best for you.
Pick the Right Mortgage Type
The different types include conventional mortgages, FHA loans, VA home loans, or jumbo financing. You can also use an adjustable-rate mortgage if you want a low initial interest rate, but you plan on owning for less than seven years before selling or refinancing. Here are a few of the most common options:
A conventional loan is a traditional financing option that allows buyers with good credit scores to take out home loans. Historically, you would put down at least 20% upfront, but it's possible to put down far less these days. Usually, these loans have 30-year fixed-rate terms that don't change over time, as long as you pay the monthly payments on time each month and stay current.
An FHA loan is a mortgage loan insured by the Federal Housing Administration. FHA loans are popular for people with lower credit scores or those who don't have enough cash on hand to cover their down payment and closing costs because they allow borrowers to put down as little as 3%.
What's more, if you use this type of financing option, there may be no out-of-pocket expenses required from the borrower at all unless they choose otherwise. Fees could include an application fee ($60), appraisal fees (typically $500-$700) and MIP, or mortgage insurance premium, currently 1.75% of your base loan amount.
The Veteran's Administration can guarantee a VA loan for veterans, active military members, and surviving spouses for 100% of the purchase price, even if you don't make a down payment.
One significant difference between an FHA and VA loan is that your monthly housing expenses can not exceed 31% of your income to qualify for one.
What are some pros and cons?
The biggest pro with this type of financing option is convenience: you'll be able to avoid paying private mortgage insurance (PMI) entirely--no matter what amount you put towards your house as long as it falls under 80%.
Another significant advantage is that there may be no out-of-pocket costs at all from the borrower other than closing costs or fees, which vary, depending on the home you're buying and where you live.
Jumbo loans are financing that exceeds the mortgage limits put in place by Fannie Mae and Freddie Mac.
The limit for a jumbo loan is $548,250 (with some exceptions).
A lender may charge more interest on an amount like this than they would on something less expensive: homebuyers may have to pay as much as four or five percentage points higher than those with conventional loans because there's a greater risk involved.
However, borrowers can get away without paying any private mortgage insurance since it only applies up to around 97% LTVs (loan-to-value ratio).
An adjustable-rate mortgage (ARM) is a mortgage with an interest rate that changes periodically. As your interest rate fluctuates, so does the payment amount.
The main perk of an ARM mortgage is that it will start with a low monthly payment.
They can be ideal for people who only plan on living in one place for a few years when the interest rate is low.
An ARM can also work out great if you have enough money saved up so that even if your payments go up, you'll still be comfortable paying them each month.
Other Types of Mortgages
In addition to the options shown above, here are some other types of mortgages you can get:
- A reverse mortgage loan is an option for seniors looking to tap into their home equity while still living in the house. This type of loan requires no monthly payments, but you have to be at least 62 and own your residence free and clear, or it has to be your primary residence.
- A HECM is similar to a conventional loan on many levels (e.g., high credit score required) and offers some unique benefits that may not exist with other mortgages. Suppose you're unable to continue paying your mortgage because of old age or disability. In that case, this type of financing can pay off the balance so long as you meet specific criteria related to income and assets.
Understand How Mortgage Interest Rates Work
Mortgage interest rates work according to what length of time you are borrowing the money for or the loan term.
The longer-term rates will be higher, while shorter-term rates tend to hover below that amount. A popular rule of thumb is that people should plan on living in their home for at least four years before refinancing or selling it. Hence, they have enough equity built up after paying down principal and interest costs.
Interest rate quotes depend upon three things: the creditworthiness of the borrower (their payment history), how much risk a lender wants to take on (i.e., how good a job can this person do managing debt?), and market volatility. Market volatility helps determine whether loans need to be locked in with fixed terms for better protection against potential changes in interest rates or general economic changes.
Choose a Good Lender
When you’re ready to start shopping around for mortgages, you’ll need to find a reputable mortgage lender. Here are some tips for choosing the best mortgage provider for you:
- Look at rates. One of the most important factors to consider when comparing mortgage rates is the APR or Annual Percentage Rate. You'll want a rate that you can afford with your budget and lifestyle.
- Customer service. It's crucial to find a lender who offers helpful customer service and is willing to help you through the process.
- Availability of products. You'll want to consider what type of mortgage best meets your needs - fixed rate or adjustable, 15-year or 30-year loan, etc.
- Loan options available in your area. Many lenders offer nationwide services, but some might be more limited by regional lending requirements. Use this information when choosing among potential providers so you can work within any geographical limitations on loans eligible for purchase in your state.
- The length of time it takes. It usually takes about six to eight weeks from the start (or pre-qualifying) until the closing day for most mortgages.
- The down payment required. You'll need to put a percentage of the purchase price into your property, usually at least 20%, but this is based on how much you can afford upfront. The higher the down payment, the lower your monthly mortgage payments will be.
- The closing costs. Closing costs include fees for title insurance, attorney's fees, surveyor or appraiser's fee (if not included with the home purchase). There's also an appraisal fee (typically $250-500 if required by the lender) and reserves for taxes and hazard insurance. Escrow account items include homeowners association dues or homeowner's warranty coverage.
You can choose from conventional mortgages, FHA loans, VA loans, or adjustable rate mortgages. How long you plan on staying in the home should affect your choice. You'll also want to figure out what you can afford, using the 28% rule.
As always, with any big decision, make sure that the choice fits your particular situation and lifestyle as much as possible before making a final decision.