Buying a home is a major milestone, but it's only half the battle. The other half is finding the right type of mortgage to fit your needs and budget. Unless you can purchase your home with cash, you'll need to borrow money from a lender and come to a legal agreement to repay the loan over a set period of time, with interest. There are two components to paying your mortgage: principal and interest.
The principal is the amount of the loan, while interest is an additional amount (calculated as a percentage of the principal) that lenders charge for the privilege of borrowing money. When it comes to mortgages, not all products are created equal. Some have stricter guidelines than others, and some lenders may require a 20% down payment while others require as little as 3%. To qualify for certain types of loans, you may need flawless credit, while other loans are geared toward borrowers with less than stellar credit.
The government does not lend money directly, but it does guarantee certain types of loans that meet strict eligibility requirements for income, loan limits, and geographical areas. To help you make an informed decision about which type of mortgage is best for you, here's an overview of several possible loan options:
Conventional LoansConventional loans are not backed by the federal government. Borrowers with good credit, stable employment history and income, and the ability to make a 3% down payment can generally qualify for a conventional loan backed by Fannie Mae or Freddie Mac. To avoid the need for private mortgage insurance (PMI), borrowers generally need to make a 20% down payment. Some lenders also offer conventional loans with low down payment requirements and no PMI.
Jumbo LoansJumbo loans are the most common type of non-conforming loans.
They are called jumbo because loan amounts generally exceed compliant loan limits. These types of loans are riskier for a lender, so borrowers generally need to show larger cash reserves, make a down payment of 10% to 20% (or more), and have strong credit.
FHA LoansLow-moderate-income buyers buying a home for the first time often turn to loans insured by the Federal Housing Administration (FHA) when they can't qualify for a conventional loan. Borrowers can put in as little as 3.5% of the purchase price of the home. FHA loans have more relaxed credit rating requirements than conventional loans.
However, all borrowers pay an annual upfront mortgage insurance premium (MIP), which protects the lender from default by the borrower for the life of the loan.
VA LoansThe Department of Veterans Affairs (VA) guarantees homebuyer loans for qualified military service members, veterans, and their spouses. Borrowers can finance 100% of the loan amount with no down payment required. Other benefits include lower closing costs (which can be paid by the seller), better interest rates, and lack of PMI or MIP.
USDA LoansThe Department of Agriculture (USDA) secures loans to help make homeownership possible for low-income buyers in rural areas nationwide. These loans require little or no down payment for qualified borrowers, as long as the properties meet USDA eligibility rules.
Fixed-Rate LoansFixed-rate loans are best for people who plan to live in their homes for a long time.
If you want to pay off your home faster and can afford a higher monthly payment, a short-term fixed-rate loan (for example, 15 or 20 years) helps you reduce time and interest payments. It will also generate equity in your home much faster. Opting for a shorter fixed-term mortgage means that monthly payments will be higher than with a longer-term loan. Review the numbers to make sure your budget can handle the highest payouts. You may also want to consider other goals such as saving for retirement or an emergency fund. Fixed-rate loans are ideal for buyers who plan to stay there for many years to come.
A 30-year fixed loan could give you leeway to meet other financial needs.