How to choose the best mortgage loan
To buy a house is a huge stage in life. But there is another important step that you must take first: deciding what type of mortgage you want to apply for.
Yes there is different types of mortgages. Your decision will likely depend on which one you qualify for, but a little strategy is involved as well.
1. Conventional mortgage vs government guaranteed mortgage
The first decision you’ll need to make is probably whether you want a conventional mortgage or a government mortgage.
A conventional mortgage is a loan from a private or federal corporate lender Freddie Mac or Fannie Mae that is not government insured. Depending on the lender, you will need a certain credit score, down payment, and debt-to-income ratio to get a mortgage.
In many cases, government guaranteed mortgages are intended for people who do not qualify for a conventional mortgage. They may also affect certain groups of people, such as military veterans or people with low to moderate incomes.
You will still apply for a government guaranteed loan through a private company, but it will be government insured. This makes it less risky for lenders to give you a loan if you do not meet the Champion loan terms.
If you have a good credit rating, some money for a down payment, and one debt-to-income ratio of 36% or less, you may want a conventional loan.
Otherwise, you can consider government guaranteed mortgages. These can be great mortgage options, but some are only intended for specific groups of people. And some have drawbacks, including higher loan limits and higher mortgage insurance premiums.
2. Compliant or non-compliant mortgage loans
If you are considering conventional mortgages, you will choose between a compliant or non-compliant loan. The main difference between these two types is the amount of money you need to borrow.
A conform mortgage meets the standards set by the Federal Housing Finance Agency (FHFA). The FHFA sets the limit for compliant loans each year, and in 2021, limit is $ 548,250 in most areas of the United States. In areas with higher cost of living, such as Alaska, Hawaii, Guam, and the U.S. Virgin Islands, the limit has been increased to $ 822,375.
A non-conforming mortgage is for an amount that exceeds the FHFA limit. You might also hear him talk about jumbo loan.
To qualify for a non-compliant mortgage, you’ll likely need a higher credit score, a larger down payment, and a lower debt-to-income ratio than a compliant loan.
If you a) need more money than the FHFA allows, and b) may be eligible for the loan, then a non-conforming mortgage may be for you. If not, then you’ll want to go with a compliant mortgage.
3. Government guaranteed mortgages: FHA, VA or USDA loan
Government guaranteed mortgages are issued by the federal government. They usually have more flexible requirements surrounding credit scores, down payments and debt-to-income ratios.
You will always go to a private lender for a government guaranteed loan, but you must specify that you want a government issued mortgage.
There are three common types of government guaranteed loans:
- Veterans Affairs (VA) Loans: You may be eligible if you are affiliated with the military.
- United States Department of Agriculture (USDA) loans: You must have a low to moderate income level and buy a house in a rural or suburban area.
- Federal Housing Administration (FHA) loans: The rules for who qualifies for an FHA loan are broader than with VA and USDA loans. You may qualify if you don’t qualify for the other two, but you will likely need more for one down payment than the others. Many VA and USDA loans do not require a down payment at all, but you will need a 3.5% down payment for an FHA loan. FHA loans also require a 1.75% mortgage premium up front, and you will continue to pay a lower premium each year.
4. Fixed rate loans vs adjustable rate loans
Once you have decided on the type of conventional or government guaranteed loan you need, there are two other types of mortgages to choose from: fixed rate or adjustable rate loans. Both of these options relate to the interest you pay on your loan.
A fixed rate mortgage lock in your rate for the duration of your loan. Although U.S. mortgage rates go up or down over the years, you’ll still be paying the same interest rate 30 years from now as you made your very first mortgage payment. The most common term for a fixed rate mortgage is 30 years, but you can choose from 20 years, 15 years, or some other term.
A adjustable rate mortgage, or ARM, keeps your rate the same for the first few years, then changes periodically over time, usually once a year.
With an ARM, your rate stays the same for a number of years, called an “initial rate period,” and then changes periodically. For example, if you have an ARM 5/1, your introductory rate period is five years and your rate will rise or fall once a year for 25 years. Most lenders offer 7/1 or 5/1 ARMs, but different lenders offer different terms.
Fixed rate mortgages are better deals than an adjustable rate mortgage right now.
Why? Because the rates are at historic lows.
With a fixed rate mortgage, you can get a very low rate for the life of your loan. But the rates won’t stay that low forever, so if you have an ARM, the rate will likely increase at some point before you pay off your mortgage.
Previously, ARM rates started lower than fixed rates, but that hasn’t been the case recently. Fixed rates are generally lower, and you can keep that rate low for decades.
Laura Grace Tarpley is Editor-in-Chief at Personal Finance Insider, covering mortgages, refinancing, bank accounts and bank reviews. She is also a Certified Personal Finance Educator (CEPF). During her four years of personal finance coverage, she has written extensively on ways to save, invest, and manage loans.