What Type of Mortgage Should I Get and Why?

what type of mortgage should i get

Shopping for mortgages isn’t as fun as other activities, but it can save you loads of money you can use for other things. It’s all about finding a product that fits you best, providing value, and avoiding financial pitfalls. 

Spending days working towards finding the right mortgage is a step that can save you thousands of dollars, if not more.

However, it’s not as easy as it sounds. The best information to have is about the different types of mortgages and why people take them. 

That way, you understand if it is the right product for you to take.

In this article, you will learn about the different types of mortgages available and which one is the right one for you.

Preparing for the Purchase

Before we get into the details of these different mortgages, it’s vital to have some preparation. Without it, you could get surprised by some of the costs and conditions that come with them.

The first thing you need to find out is your budget. You need to have enough money to pay for the mortgage and still have some for other expenses. 

Getting a precise number is almost impossible without a query, but there are calculators you can use to estimate.

You can determine if you already have the finances to pay for the mortgage or if you need to save more money. Remember that you’re paying for a down payment and many other costs associated with dealing with these organizations. 

Finding a balance between the money you put out and the money left behind is essential. If your down payment is too small, you’ll get higher monthly payments that could eat your income.

Apart from saving up, there are two other factors you need to consider when you start inquiring about brokers.

  • Mortgage Length - The average loan will have you committed for 30 years, but many other plans don’t. Check the cost of 10 to 15 year loans to see if they’re affordable. The longer you stay, the more you will pay during its lifetime.
  • Mortgage Rates - Interest rates are another defining factor that will sway your decision. These numbers change a lot within a year, so knowing the current prices will be pivotal. It also means you have to determine what type of agreement you’ll have with the interest rate.

 

What are the different Types of Mortgages

On average, lenders can require around 20% of the home’s down payment (with some exceptions). It depends on the type of loans available to you and your credit score.

A higher credit score will land you better plans overall. You’ll receive a lower interest rate, a higher ceiling, and other features unavailable to others. 

With that said, here is each type of mortgage and why you may want them:

 

Conventional Mortgage

Conventional mortgages are loans offered by Fannie Mae and Freddie Mac. These two groups buy and sell most of these mortgages in the country.

As the name implies, this is the standard loan offered to borrowers. If you have good credit and stable employment, you can qualify for one. 

However, most of these plans require a 20% down payment to avoid getting private mortgage insurance (PMI). 

If you pay lower than that, the PMI will be a factor to consider in your future payments.

PMI essentially mitigates the risk since the lender extends more money for the mortgage. It is a fee that adds on top of your monthly payments, remaining until you reach a specific equity within the home.

There are two types of conventional loans:

  1. Conforming loans: These loans conform to the set standards of the FHFA, the housing finance authority. They are responsible for setting the limit on loan sizes.
  2. Non-conforming loans: These loans do not meet the FHFA standards. These are usually available for purchasing expensive homes or those with lower credit scores than average.

While conventional loans are available with Fannie Mae and Freddie Mac, they are not limited to these. You can find private lenders that offer conventional mortgages, though the requirements vary. 

Some may offer no PMI, while others may have lower payment requirements. It’s the reason shopping among different lenders is vital to help provide the best option available.

 

Jumbo Loans

A jumbo loan has requirements beyond what the FHFA recommends (non-conforming loans). The cities that offer these have higher median price points than the rest of the country. 

You see them in areas like:

  • Hawaii
  • New York
  • San Francisco
  • Los Angeles

Even if the FHFA sets higher limits for these areas, prices for homes here tend to be higher than average.

With a jumbo loan you can borrow more than a conventional with similar interest rates. However, they usually require a very high credit score and at least 10% in down payment.

Lenders will also scrutinize your debt and see if you have enough space to afford the mortgage. A debt-to-income ratio of below 45% is ideal in most scenarios.

You must also provide enough savings and income sources to cover the mortgage.

Why would you want a jumbo loan? A jumbo loan is ideal for those looking for houses beyond the limits of conventional loans.

If you desire higher financing, it is your best choice. As such, jumbo loans are often for those with more income and liquidity than your average person.

 

Federal Housing Administration (FHA) Loans

The FHA offers a mortgage for those who cannot qualify for conventional loans. They are for low to moderate-income households looking to buy their first home.

 

One of the advantages of the FHA loan is a significantly lower down payment. You can buy a house with a down as low as 3.5%.

 

They also have lenient requirements compared to conventional loans. While it is named the FHA loan, funding comes from lenders approved by the company.

Looking at a glance, it seems too good, but there is a catch. Those who get into FHA loans must pay an insurance premium for the entire loan’s lifetime. 

Since borrowers come with higher risk, it is necessary to protect the lender.

Getting an FHA loan is ideal for those with a credit score in the 500s. A higher score will provide a better chance of getting a loan with a 3.5% down payment. 

If not, you may need to bring a 10% down.

 

USDA Loans

The USDA is also a government-insured loan, allowing buyers to afford homes that may otherwise be outside their budget. These loans are only available to low to moderate-income borrowers and should have specific income limits.

 

They can also only buy homes within rural areas deemed eligible by the USDA.

 

While the barrier to these loans is low, you’ll also have to pay an upfront fee of 1% of the loan amount and an annual fee. These are usually incorporated, and borrowers don’t have to put much out at the start.

The USDA opened these loans to help bring more people to rural areas. It will also inherently boost the nation’s agriculture sector, as most of these properties are available as farmlands.

Some USDA loans need no money as a down payment if the applicant meets eligibility.

With relaxed credit requirements, USDA can be an option for those who don’t have much cash but want homeownership. The only catch is the location of the property. 

Those who are willing to get into USDA loans must be those interested in buying farmlands or live in areas far from major cities.

 

VA Loans

VA loans are available for active duty and veteran US military members. It’s one of the benefits of serving the country as the government will open low-interest mortgages for them and their families. 

VA loans probably provide the most significant benefits among all government-insured loans. You do not need any down payment, minimum insurance scores, or mortgage insurance.

The government also sets a cap on the closing costs, which can go in the plan. One of the only additional fees within these loans is the funding fee.

It is a percentage of the loan amount that one can pay upfront or roll into the loan with other costs.

VA loans provide many enticing options, but they are only limited to the US military. Veterans and serving members should look into the options available for VA loans. 

The only other catch is that VA loans require the buyer to live in a property, though it is the same for other government-insured loans. There is an option for a borrower to finance a multi-unit building which they can then rent out to other units.

 

Insurance Rate Mortgages

All the other mortgages above can have varying insurance rates. It is the amount that you need to pay the lender on top of the loan for letting you borrow the money. 

It is the primary way of making money from insurance plans, and rates can vary depending on the lender. There are two main insurance types you should know:

 

Fixed-Rate Mortgage

A fixed-rate mortgage means that you’ll pay the same interest for the entire lifespan of the loan. For example, if you take a loan for 30 years, the extra payments on top of the loan will remain the same until you complete the amount.

 

Fixed-rate mortgages usually vary between 8 to 30 years, depending on the lender.

 

One of the advantages of getting a fixed-rate loan is that it’s easier to budget your expenses. You know what to pay each month and can set aside money before looking at other things you need to pay. 

Getting assurance of that payment for the rest of the loan’s lifespan can also give peace of mind to some.

However, the issue with fixed-rate mortgages is that you’ll often pay more interest in the long term. They also tend to start at a higher rate than adjustable-rate mortgages or ARMs.

One way to go around this is to try and pay the mortgage as early as possible. That way, you reduce the time needed to pay the fixed rate. 

You’ll also pay lower interest.

 

Adjustable-Rate Mortgage (ARM)

On the opposite end of fixed-rate is the adjustable-rate mortgage. Whereas the other remains fixed, this one changes the rate depending on market conditions. 

Because of that, you can get a potentially lower rate than a fixed one or get a higher one.

Most of these plans have a period that eases you into the adjustable rates. 

For example, your mortgage may have a fixed amount for seven years before it begins changing its rates. From there, the rates will change every six months.

Read the fine print first if you ever consider getting an ARM. You need to know how much the rate can increase and how long the fixed rate persists. 

You don’t want to end up where your finances aren’t ready for the shift in rates.

The ARM gives you the potential to save money on interest rate payments, but it also exposes you to risk. The risk of paying more than a fixed rate for six months or longer is always present.

Another problem with the ARM is when home values go lower. During those times in the market, it can be hard to refinance the loan or sell the property. 

You’ll have to endure paying the ARM until market conditions become better.

 

What type of mortgage is right for you?

Before pursuing a loan, check your credit report to get an idea of what’s available to you. You can acquire these for free each year, once for each of the three main bureaus. 

You’ll know what to do to improve your score and pursue a loan.

It’s all about preference and what you need at the moment. Each loan offers pros and cons with them.

If you need advice on what type of loan to get or need help financing, consult with 121 Financial Credit Union. Our goal is to help our members find the right financial solutions for their needs, including mortgages.

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