Buying a new home can be the most exciting purchases you will ever make. Whether it’s your first home as a newlywed couple, or the long-awaited dream home where you intend to enjoy retirement, understanding what types of home loans are available, will save you stress in the long run!
Oftentimes factors such as credit score and income play a large part in what you can afford, however, rest assured there is a loan out there for you, regardless of your circumstances! Let’s look at a few of the main types of home loans to help you better understand your options. Knowing what loans are available to you, and how they work, will set you up for success in choosing which home loan you can afford.
FHA loans are insured by the Federal Housing Administration, which acts as a back up in the case of nonpayment. This type of loan requires the homeowner to pay for private mortgage insurance. This insurance is paid as an initial premium payment at closing, as well as a monthly insurance payment on top of that. FHA loans are very commonly used with first time home buyers, due to its low requirement of only 3.5 percent down payment. Applicants are required to have a minimum FICO score of 580 to qualify for the 3.5 percent down. You can still receive an FHA loan with a FICO score below 580, but it will require a much larger 10% down payment. FHA loans generally have lower closing costs, require less credit history, and offer lower interest rates, making it a great option for many homebuyers.
Conventional Fixed Loans
These loans are not backed by a government agency like the FHA. Because they are not guaranteed by the government, they are considered riskier by lenders and therefore have tougher requirements. Conventional loans require at least a 20 percent down payment, but do not require private mortgage insurance. Requirements vary by lender, but 620 is the typical minimum score required to qualify for a conventional fixed loan. These loans are available in 10, 15, 20, 30, and 40-year terms, although the most common are 15 and 30- year terms. If you have the means to put down 20 percent on your home loan, and avoid having to pay for private mortgage insurance, you will save significantly on your monthly payment.
VA loans are guaranteed by the U.S. Department of Veterans Affairs. These home loans are available only to veterans of the U.S. armed forces, service members, and occasionally their spouses. This type of loan was created by the U.S. government in 1944 to help returning service members purchase a home without needing a down payment or great credit. As was mentioned, these loans require zero down payment, and private mortgage insurance is not required. Generally, VA loans have a more competitive interest rate compared to non-VA loans. With benefits like these, veterans would do well to take advantage of this type of loan when buying their home.
Adjustable Rate Mortgages (ARM)
Adjustable Rate Morgages, or variable-rate mortgages, are loans in which the interest rate can vary over time. This rate is based off the economy, and the cost of borrowing money at the time. There are different types of ARMs. One common type of ARM is a 5/1. As an example, with this type of loan the interest will stay the same for the first 5 years, and then will become adjustable for the following 25 years. The interest rate will reset every year following the initial 5 years. The main benefit of using an adjustable rate mortgage, is that you will receive an extremely low initial interest rate. In general, ARM mortgage rates start out about 0.5 percent lower than fixed-rate loans. Despite having lower monthly payments during the initial lower interest period, some homeowners chose to make their payments as if it were at a standard interest rate. This allows a much larger portion of the principal to be paid off every month, gaining a large amount of home equity in a noticeably short period of time. ARM loans are particularly appealing when conventional interest rates are high. Lenders may set their own credit score standards, but the FHA will guarantee loans for borrowers with scores as low as 500. In addition to helping those with low credit scores, the ARM may also be a good option for someone planning to sell or refinance within a few years.
USDA Home Loan
The USDA home loan is a unique loan. The home you purchase must be located in the eligible rural or suburban area as defined by the USDA, but if your home qualifies, you’re looking at zero down payment and a low interest rate. These loans are guaranteed by the United States Department of Agriculture (USDA). Because of the USDA guarantee, eligibility requirements are lenient, provided your home is in a qualifying location. The USDA’s definition of “rural” has expanded more recently to include many small towns, suburbs, and outlying areas of major U.S. cities. Mortgage rates are often lower than FHA or conventional loans. The minimum credit score needed to receive this loan is 640. If you don’t mind living away from the hustle and bustle of the city, a USDA loan may be the perfect fit for your lending needs.
Interest Only Loans
Interest only loans allow the borrower to pay only on the interest of their loan for the first 5-10 years. After the initial period of paying interest only, the loan is paid off as a conventional loan would be, with principal and interest included monthly. Interest only home loans require a higher credit score, with a minimum of 720. These also require a higher income and down payment in comparison to several of the loans mentioned previously. This type of loan slows down repayment of principal, so equity in the home is not seen until much later on. First time home buyers who can only afford a low mortgage payment may consider this loan, however, be aware that your mortgage will go up significantly after the initial 5-10 years. This type of loan can also be helpful for someone looking to buy a fixer upper, with the intention of selling right away. This will free up more money to put towards renovating the home.
Now that you have a better understanding of what types of home loans there are, you can be confident that you will make the right choice. Happy house hunting!