Buying your first home, a home for a growing family, or a retirement home is a life-changing experience. However, understanding all the ins and outs concerning the best mortgage for you and your stage of life can be downright overwhelming.
Never fear, once you get familiar with the different types of mortgages, the pros and cons, and the financial lingo, you’ll be ready to put a downpayment on your next home sweet home. Here are the details on the main types of mortgages available for U.S. homebuyers:
1. Adjustable-rate mortgages
Adjustable-rate mortgages (ARMs), also known as variable rate mortgages, offer fluctuating interest rates based on current the housing market. ARM loans may come with an initial fixed-rate period of between 3- and 10-years where the interest rate is fixed. However, once the initial term is met, the interest rates reset to variable for the remaining loan term. While ARMs can be tempting to first time homebuyers who want a low interest rate for their first few years of ownership, be sure to get an ARM that caps the max interest rate or monthly mortgage payment so you don’t end up with sky high rates when the loan resets.
2. Fixed rate mortgages
Fixed-rate mortgages (FRMs) are exactly what the name suggests—they offer one interest rate that remains the same over the life of the loan. That’s great news if you like to stick to a budget with a 15-, 20-, or 30-year term mortgage with no surprises when it comes to the monthly payment, which will always be the same amount. However, keep in mind that interest rates tend to be a bit higher with fixed rate vs. adjustable rate mortgages so you’ll pay more interest on a long term loan and take longer to build your home equity. However, the stability of interest rate and monthly payments is attractive to homeowners who expect to live in the same home for up to 10-years.
3. Government-insured mortgages
Many who don’t qualify for conventional loans due to low credit or no savings, opt for higher government-insured mortgages. U.S. government mortgages are flexible and offer insurance by one of 3 organizations:
- The U.S. Department of Veterans Affairs: Offering flexible, low-interest mortgages specifically for active duty and veterans of the U.S. military, VA loans require zero in down payment with a funding fee and capped closing costs that are typically paid by the seller upon closing or rolled into the actual loan.
- The U.S. Department of Agriculture: These low income loans are meant to urge home sales in USDA-eligible rural areas. Many don’t require a downpayment.
- The Federal Housing Administration: Are aimed at lenders with low credit scores (between 500 to 580 FICO score) at 3.5% with zero to 10% downpayment. These loans have one mortgage insurance premium paid yearly for the entire loan term and another paid at closing.
4. Conventional mortgages
This insured federal government loan comes in two types:
- Conforming conventional loans, which falls under maximum limits set by the Federal Home Loan Mortgage Corporation (aka: Freddie Mac) or the Federal National Mortgage Association (aka: Fannie Mae), which back the majority of mortgages in the U.S.
- Non-conforming conventional loans, which exceed the maximum limits set by government-sponsored limits (i.e., jumbo loans).
Conventional loans often demand private mortgage insurance if your down payment is less than 20% of the house price. This is attractive to buyers with low credit ratings or low down payments of only 3%, who can borrow low to purchase a first time home, second home, or investment property. The interest rate may be higher, but the lender will cancel private mortgage insurance once you’ve paid down 20% of the home’s equity.