Most people do not have the means to purchase a home outright in one lump sum. Instead, financing options allow homebuyers to pay for a house in increments over time. If you want to buy a home but need financing for this major investment, consider securing a home loan.
Home loans come in the form of mortgages, or legal agreements with banks or other lenders. Mortgages lend money with interest in exchange for the title of the debtor’s property. Upon repayment of the debt, the conveyance of the title becomes void and the house belongs to the purchaser. Explore the types of mortgages to discover which might be right for you.
Different Types of Mortgage Options
The fixed-rate mortgage is the most common type. Homeowners pay off the mortgage over a preset amount of time at a specified and agreed-upon interest rate. The timeline for fixed-rate mortgages can be 10, 15, 20, or 30 years. The main advantage of a fixed-rate mortgage is that the interest rate won’t increase, even though market rates may change. You have a sense of security with a fixed-rate mortgage agreement because you won’t have to worry about your interest rate growing.
In a fixed-rate mortgage scheme, the shorter the timeline, the lower the interest rate. A 10-year mortgage agreement, for example, will come with lower interest rates than a 30-year agreement. This type of mortgage is best for people who are worried about monthly payments fluctuating and for those who don’t plan on moving in the next 10 years. If you do plan on moving, a mortgage with a lower adjustable rate may be more appropriate. Fixed-rate is the conservative option for long-term agreements, as you’re paying for the security.
Adjustable Rate Mortgage (ARM)
Another traditional type is the adjustable rate mortgage (ARM). As the name applies, the interest rate on this type of mortgage is adjustable. The bank or lender has the power to raise or lower the interest rate as market prices fluctuate. With this type of mortgage, your monthly rates can rise and fall. If you require more stability in what your mortgage payment includes each month, the adjustable rate setup is probably not for you.
The benefit of an ARM agreement is that it can come with lower interest rates than fixed-rate mortgages, leaving more room in your monthly budget. There is typically flexibility in the terms of these mortgages. Most of these mortgages come with caps, or limits, regarding how much your rate can move from period to period. Make sure you have a thorough understanding of how ARMs work before entering into this agreement. It can be confusing for homeowners. Those with good credit scores can get the best rates on ARMs, while those with lower scores may be better off with fixed-rate mortgages.
A hybrid ARM agreement is a cross between fixed rate and adjustable rate. It offers an initial fixed-rate interest period followed by a period where the rate will be adjustable. The initial non-adjustable period can range from three to 10 years (sometimes longer). After that, it will turn into a traditional ARM with an interest rate that is susceptible to change from period to period. Hybrid ARMS are typically available at lower rates that traditional fixed-rate mortgages. Hybrid ARMs are best for those with the means to handle fluctuating payments and jumps that may occur when the fixed-rate period ends.
Federal Housing Administration (FHA) Loan
A loan from the Federal Housing Administration (FHA) is another type of mortgage agreement. An FHA loan may be appropriate for buyers who do not have enough savings to make the down payment on the property. In this agreement, the FHA insures the mortgage to protect the lender if the debtor defaults on the loan. Because of this insurance, lenders often offer FHA loans at lucrative interest rates and flexible requirements. FHA loans are popular options among first-time buyers, those with low credit scores, and people who need smaller down payments.
In an FHA loan agreement, the minimum down payment is usually just 3.5 percent (down from the typical 10 percent down payment requirement for a house). The FHA will accept grants from state and local governments to make the down payment. The borrower must also pay two mortgage insurance premiums up front – 1.75 percent of the loan amount and the annual premium (paid monthly). The length of the loan can determine premiums. Consider an FHA loan if you think you will need financial hardship relief down the road, such as temporary forbearance or an interest modification.
Veterans Administration (VA) Loan
Another home loan agreement that’s available for military veterans comes from the VA. Qualifying homebuyers such as active military, military families, and veterans can receive special benefits using this type of loan. VA home loan benefits can include zero down payment, no mortgage insurance, lower interest rates, and more favorable loan terms. The U.S. Department of Veterans Affairs guarantees these loans. If you qualify, a VA loan is usually the best selection.
United States Department of Agriculture (USDA) Loan
A USDA loan may be appropriate if you’re shopping for a home in a rural or suburban area and if you can’t qualify for a traditional mortgage agreement. The USDA will provide home loans at zero down payments and low interest rates. The point of the program is to improve the quality of rural living in America. If you qualify for a USDA loan, you may enjoy no down payment. If you put little to no money down, however, prepare for an insurance premium payment. Low-income applicants may benefit the most from a USDA home loan.
If you’re over the age of 62, you may qualify for a reverse mortgage. In this type of loan, the homeowner gives up equity in the home in exchange for regular payments from the lender – typically to supplement Social Security income. The homeowner can use the cash from the FHA as monthly income, to pay unexpected medical bills, to make home improvements, or to fund retirement. The borrower doesn’t have to repay the money until he or she dies or sells the home. To qualify for a reverse mortgage, the borrower has to own the home outright or have a low remaining mortgage balance.
Talk to a financial advisor to learn more about the types of mortgages and to decide which agreement is right for you.