Decision 1: Assess your situation
Before considering your loan options, assess your situation and your needs can help you pick a loan that fits your unique circumstances. There are several factors to consider that may likely impact your loan options:
Potential home cost
Financial well-being
Life plans
Are you planning to stay in your new home for only a few years or is this your forever home? The average American is expected to move approximately 11.4 times in his or her life. Depending on your career plans or life events, you might move shortly after buying a home or you might stay for decades. This may affect the mortgage option you should choose. For example, the longer you plan on staying in your home, the riskier an adjustable-rate mortgage (ARM) may be.
Decision 2: Loan Terms
Typically, homebuyers get a 15-year or 30-year mortgage, though there are many options on terms of a loan depending on your loan type. The term length indicates how long you have to pay off the loan. On a 30-year mortgage, you’ll generally have a lower monthly payment compared to a 15-year mortgage, but you’ll pay more in interest over the life of the loan.
Decision 3: Interest Rate Type
As a borrower, one of your first choices is whether you want to lock the rate, make it adjustable, or do a combination of both. All loans fit into one of these two categories, or a combination "hybrid" category. Here's the primary difference between the two types:
Fixed Rate
Description: A fixed rate loan offers a stable interest rate amortized over the life of loan, which are most often set in 15, 20, or 30 year terms.
Advantages: Your monthly payment stays the same over the entire life of your loan. No worry about rising interest rates.
Disadvantages: The rates on a fix rate loan can be higher than a adjustable rate (ARM) loan. If interest rates drop after you’ve locked in your loan rate, you may be stuck with a higher monthly payment.
Consider If: You plan on staying in your home long-term and like the guarantee that, whatever else changes, your house payment will stay the same.
Adjustable Rate (ARM) or Variable Rate
Description: A variable rate mortgage or ARM usually offers a low introductory interest rate over a 3, 5, or 7 year term. After the initial-rate period ends, the interest rate fluctuates based on market trends.
Advantages: Introductory rates are often lower than rates for conventional mortgages, offering short-term savings.
Disadvantages: If interest rates rise after your initial-rate period your monthly payments could go up.
Consider If: You’re confident you’ll be out of your home before the end of the initial-rate period or you plan to refinance.
Decision 4: Type of Loan
A conventional mortgage is a home loan that’s not insured by the federal government. There are two types of conventional loans: conforming and non-conforming loans. A conforming loan simply means the loan amount falls within maximum limits set by Fannie Mae or Freddie Mac, government agencies that back most U.S. mortgages.
Conventional Mortgages
Conventional loans can be categorized a few ways based on the size of the loan. Depending on the amount you are trying to borrow, you might fall into either the conforming or jumbo (non-conforming) category. Here's the difference between these two mortgage types.
Conforming Loans
Description: Conforming loans meet the underwriting guidelines of Fannie Mae or Freddie Mac. In 2019, the conforming loan limits in California range from $484,350 to $726,525 for a single family home (SFH) depending on which county the property is in.
Advantages: Low down payment <20%. You can put down as low as 3% if you meet specific criteria for eligibility. Rates are usually lower for conforming vs non-conforming loans.
Disadvantages: Private mortgage insurance (PMI) is typically required if you borrow more than 80% of the value of the home
Consider If: You don’t have a large down payment. If you are looking for a lower interest rate and want the peace of mind of knowing your lender meets Fannie and Freddie guidelines.
Jumbo (non-conforming) Loans
Description: Jumbo loans are the most popular type of non-conforming conventional mortgages. Jumbo loans are for amounts exceeding $484,350 to $726,525 depending on the county. Jumbo loans exceed the conforming loan limits established by Fannie Mae and Freddie Mac.
Advantages: Jumbo Loans make it possible to purchase large homes and help finance home purchases in states with high home costs.
Disadvantages: Jumbo loans often require 20% down payments and interest rates can be .25-.50 higher than comparable conventional loans.
Consider If: You want to purchase a large home or live in a high-cost area.
Specialty Mortgages
Proprietary Reverse Mortgages
Description: Reverse Mortgages are private loans that lack the government insurance of HECMs. This type of mortgage is for seniors aged 62 and older with substantial equity in their property. With this loan, the lender pay the borrower either a single lump sum disbursement.
Advantages: Allows seniors to convert their home equity into cash, which is often used for living expenses. The loans and interest don’t have to be paid back as long as the borrower lives in the home. There is typically no income requirement or property value limit.
Disadvantages: Often an area of fraud by unethical lenders who prey on the elderly. If you’re considering a Reverse Mortgage, make sure your lender is reputable and the loan is federally insured.
Consider If: You’re retired and need extra monthly income.
Interest Only
Description: A borrower pays only the mortgage interest, in monthly payments, over a fixed term.
Advantages: Without paying principle, monthly payments are often less than fixed rate or adjustable rate loans. You can make payments on the principal whenever you want on an interest-only loan.
Disadvantages: With Interest Only loans, the balance is often due in a lump sum after the initial period ends. This could mean significantly higher monthly payments after the ¨teaser period¨ or facing a large lump sum payment.
Consider If: New homeowners still trying to sell their previous property. Once they sell their house, they can make a lump-sum payment toward the principal balance on their interest-only loan. If you plan to live in the home for only a short amount of time or have confidence you can handle the larger payment down the road.
Bridge Loan
Description: A type of short-term financing where the funds are used to “bridge” some kind of financial gap. For people in your situation (residential real estate), this type of loan can help cover the cost of a down payment on the second home, by using the equity you have in your current home as collateral. You would then repay the bridge loan with the proceeds from the sale of your first home.
Advantages: A buyer can buy a new home and put the existing home on the market with no restrictions. You can still buy a new home even after removing the contingency to sell under certain circumstances
Disadvantages: You might pay a higher interest rate and fees on the bridge loan. The closing costs that are applied to bridge loans can make them cost-prohibitive. If your old home doesn’t sell within the expected time frame, you could end up with two mortgage payments at the same time.
Consider If: You need funds to finance the purchase of real estate properties before selling your current property in areas in which homes sell quickly.
Government Backed Mortgages
A government-backed loan is a loan subsidized by the government, which protects lenders against defaults on payments, thus making it a lot easier for lenders to offer potential borrowers lower interest rates. Its primary aim is to make home ownership affordable to lower income households and first-time buyers.
FHA Loans
Description: Allows buyers who may not qualify for a conventional mortgage to obtain financing with a lower down payment.
Advantages: First-time homebuyers or individuals who may not qualify for traditional funding have better access to home financing.
Disadvantages: Not everyone will qualify for FHA funding and even if you do, there may be restrictions on how much you can borrow or what types of property you can buy.
Consider If: You’re a first-time homebuyer or have low income and/or challenged credit.
VA Loans
Description: These loans are offered through the US Department of Veteran’s Affairs to eligible Veterans, active duty personal, or surviving spouses.
Advantages: VA Loans offer competitive rates, often with low or no down payments. No mortgage insurance required
Disadvantages: As with FHA loans, the size of your loan may be limited.
Consider If: You’re a veteran, active duty personnel, or surviving spouse.
USDA / RHS Loans
Description: These loans are offered through the The United States Department of Agriculture (USDA) for rural borrowers who meet certain income requirements. The program is managed by the Rural Housing Service (RHS), which is part of the Department of Agriculture.
Advantages: Rates for USDA loans are generally lower than comparable, 30-year fixed-rate mortgages. Even if you have less-than-stellar credit, you may still get a lower rate with a USDA loan because of the agency promises to reimburse the lender should you default and allow a foreclosure.
Disadvantages: USDA loans are only available in 34 states, must be for your primary residence and not all homes are avialable for this type of loan.
Consider If: You are looking to purchase in a rural area
Home Equity Conversion Mortgages (HECM)
Description: These federally insured loans are for seniors aged 62 and older with substantial equity in their property. With this loan, the lender pay the borrower either a single disbursement, line of credit or a fixed monthly payment for as long as they live in their home.
Advantages: Allows seniors to convert their home equity into cash, which is often used for living expenses. The loans and interest don’t have to be paid back as long as the borrower lives in the home. There is typically no income requirement.
Disadvantages: HECMs in 2018 are limited to properties worth $679,650.
Consider If: You’re retired and need extra monthly income.
Decision 5: Understanding Loan cost and fees
There are a few costs and fees associated with every loan. When comparing loans, your monthly payment amount may depend on the interest rate and point mix. Points are fees that you can pay upfront to decrease your interest payments over the term of the loan. Those homebuyers wishing to stay in their home for a long time may want to consider buying points upfront to help reduce their payments over the lifetime of the loan.
Your mortgage lender is required to provide a Loan Estimate within three business days of receiving your application. This form goes over important details about the mortgage, usually including your estimated interest rate, monthly payment and total closing costs for the loan. Closing costs can include fees for the home appraisal, credit report, documentation preparation, HOA fees, loan origination fees, taxes, title fees, PMI (private mortgage insurance), etc. Lenders are required to use the same form, which can make it easier for you to compare loans.
