Buying a new home can be the most exciting purchase 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. 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. Know what loans are available to you, and how they work. This will set you up for success in choosing which home loan you can afford.
FHA loans will be insured by the Federal Housing Administration. This 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. Additionally, this acts as a monthly insurance payment on top of that. FHA loans are typically used with first time home buyers, due to its low rule of only 3.5 percent down payment. A need to have at least a 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 need a much larger 10% down payment. FHA loans generally have:
- lower closing costs
- less credit history
- offer lower interest rates
This makes it a great option for many home-buyers.
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 riskier by lenders and thus have tougher requirements. Conventional loans need at least a 20 percent down payment. But do not need private mortgage insurance. Requirements vary by lender. 620 is the typical smallest 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, do so. Avoid having to pay for private mortgage insurance. You will save on your monthly payment.
Guaranteed by the U.S. Department of Veterans Affairs. These home loans are available only to veterans of the U.S. armed forces. They are also available for service members, and now and then, their spouses. This type of loan was created by the U.S. government in 1944. The aim was to help to return service members to buy a home without needing a down payment or great credit. As mentioned, these loans need zero down payment. and private mortgage insurance is not required. Generally, VA loans have a more competitive interest rate compared to non-VA loans. Veterans would do well to take advantage of this type of loan when buying their home.
Adjustable Rate Mortgages (ARM)
Adjustable Rate Mortgages, or variable-rate mortgages. These are loans in which the interest rate can vary over time. This rate is based on 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. Then it will become adjustable for the following 25 years. The interest rate will reset every year following the initial 5 years. There are benefits of using an adjustable-rate mortgage. One is that you will receive a low initial interest rate. In general, ARM mortgage rates start out about 0.5 percent lower than fixed-rate loans.
Some homeowners chose to make their payments as if it were at a standard interest rate. Despite having lower monthly payments during the lower interest period. This allows a much larger part of the principal to pay off every month. This gains a large amount of home equity in a short period of time. ARM loans are particularly appealing when conventional interest rates are high. Lenders may set their own credit score standards. The FHA will guarantee loans for borrowers with scores as low as 500. This helps 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 buy must be located in the eligible rural or suburban area. This is 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. This includes many small towns, suburbs, and outlying areas of major U.S. cities. Mortgage rates are often lower than FHA or conventional loans. The least credit score needed to receive this loan is 640. Perfect 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. It is the same as a conventional loan would be, with principal and interest included monthly. Interest only home loans need a higher credit score, with at least 720. These also need a higher income and down payment. Compare this to several of the loans mentioned before. 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. But, be aware that your mortgage will go up a lot after the initial 5-10 years. This type of loan can also be helpful for someone looking to buy a fixer-upper. As long as the intention of selling it 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!
Additional reading on “Types of home loan”
On top of that, you may find our “Motrtgage Rates” page informative.