How To Finance a New Home
Different Types of Mortgage Loans
There are different types of mortgage loans, each with their pros and cons. Your loan will be determined by your specific situation, taking into account factors such as your credit rating and the size of your down payment.
Fixed-Rate Mortgage or Adjustable-Rate Mortgage
If you’re planning to stay in your new home for the foreseeable future, a fixed-rate mortgage gives you several advantages:
- The rate is securely locked in for the life of the loan (30, 15, or 10 years).
- If interest rates go down you can always refinance, but you are protected if interest rates go up.
- It’s easy to make a budget because the payment is always the same.
The disadvantages of a fixed-rate mortgage are:
- Initial interest rates are higher than an adjustable mortgage.
- If you do refinance, you’ll be liable for closing costs.
An adjustable-rate mortgage (ARM) gives you more leeway than a fixed-rate loan, which is good if you’re planning to sell the house in a few years. The advantages of an ARM are:
- Lower interest rates compared to a fixed-rate mortgage
- You might qualify for a larger loan and be able to buy a more expensive property.
- Good if you’re planning to sell soon after the purchase.
However, ARMs come with significant risks that make it a good idea to have a financial fall-back cushion if things go wrong.
- The payments can go up significantly if interest rates rise.
- It’s a good idea to make extra payments to build equity quickly in case rates skyrocket.
There are different types of ARM, depending on the initial fixed-rate time period:
- 5/25 – Rate is fixed for the first 5 years, then changes once and stays the same for the life of the loan
- 10/1 – Rate is fixed for the first 10 years then changes every year after that.
- 5/5 and 5/1 – Rate is fixed for the first 5 years then changes every 5 or every subsequent year.
- 3/3 and 3/1 – Rate is fixed for the first 3 years and changes every 3 or every subsequent year.
- Balloon mortgage – Small initial yearly payments with a large payment at the end of term. These are good if you’re planning to flip the property.
Government-Insured Loan Or Conventional Loan
A conventional loan is just what it says – a ‘normal’ loan that isn’t guaranteed by the federal government. However, some homeowners might qualify for a government-insured loan. This type of loan allows you to make a lower down payment or get a loan with less-than-stellar credit history, since the government shoulders the risk for the lender. The homeowner does have to pay for mortgage insurance, though, so the total monthly payments will be higher than with a conventional loan. The main types of government-insured loan are:
- FHA Loans – The Federal Housing Administration insures the loan, allowing you to pay a down payment as low as 3.5%.
- VA Loans – Guaranteed by U.S. Department of Veterans Affairs for military service personnel, allowing for 100% financing with no down payment.
- USDA / RHS Loans − The United States Department of Agriculture provides these loans for low-income rural homeowners.
Conforming Loan Or Jumbo Loan
A conforming loan meets the underwriting guidelines for Freddie Mac and Fannie May, especially when it comes to the size of the loan. A loan for a larger amount is called a jumbo loan, and usually requires an excellent credit rating and large down payment. The interest rate is typically higher as well.