Home Loan Options
If you are ready to buy a home now or plan to in the near future, understanding the various loans which are available is very important. At first glance the number of choices may seem overwhelming. But a reputable lender will be able to explain your options in easy-to-understand language so that you can make the right decision with regards to your own personal circumstances.
Once you have determined how much you can afford to pay each month for a mortgage payment (including taxes and insurance), then you are ready to select the type of loan which works best for your financial situation.
Understanding Loan Options
The major loan types to choose from are:
With this type of mortgage, the interest rate remains the same throughout the entire life of the loan. Generally your monthly principal and interest payments will never change. Since you have the security of always knowing what your payment will be, fixed-rate mortgages usually have a slightly higher initial interest rate than adjustable-rate mortgages.
A fixed-rate mortgage may be a good option if:
- You plan to stay in your home at least 5-7 years.
- You don't want to take a chance that interest rates will rise in the future.
- You want the stability of knowing you will have the same mortgage payment every month.
- You can afford a slightly higher monthly payment for the first few years of the loan.
You want to pick a loan which best suits your personal financial needs. Keep in mind that a fixed-rate mortgage with shorter terms (for example, 15 years instead of 30) will usually have a lower interest rate. This allows you to build equity faster and also results in a lower total amount of interest paid over the life of your loan. However, fixed-rate loans with longer terms have lower monthly payments but you will end up paying more in total interest.
An FHA loan is a mortgage insured by the Federal Housing Administration, a government agency within the U.S. Department of Housing and Urban Development. Borrowers with FHA loans pay for mortgage insurance, which protects the lender from a loss if the borrower defaults on the loan.
Here are some important facts to know about FHA loans:
- The FHA doesn't require a minimum credit score, so less than perfect credit is ok.
- The minimum down payment is 3.5% of the purchase price of the home.
- Closing costs are sometimes covered.
- Lenders must be FHA approved.
- Mortgage insurance is required for all loans.
FHA approved lenders usually can offer FHA loans at attractive interest rates. They also have more flexible qualification requirements for borrowers.
Adjustable-Rate Mortgage. (ARMs)
An adjustable-rate mortgage initially comes with fixed-rate terms of 3, 5, and 7 years. This is expressed as 3/1, 5/1, and 7/1 ARMS. This means that the interest rate of the loan will be fixed at a certain rate for the first 3, 5, or 7 years of the mortgage loan. After this time period, the rate will be adjusted annually for the remaining life of the loan.
The interest rate tends to be lower during the introductory period which results in lower monthly payments. But when this period ends, your interest rate will go up or down according to the market index.
Before making a decision about an ARM, consider these questions:
- Will I have enough money to cover larger monthly payments if my interest rate goes up?
- Will I be taking on more significant debt in the near future, such as car loan or school tuition?
- How long do I want to own this home? If you plan to sell your property before the introductory period ends, an ARM may not pose any problems for you.
- If interest rates stay about the same, can my monthly payment still increase?
Lenders are required to give you written information to help you compare and select a mortgage. Be sure to ask questions so that you understand every aspect of ARMs and other home loans that are offered to you.
Interest-Only Mortgage. (IO)
Interest-only payments do not contain principal. The most popular IO mortgages limit the time that a borrower may make interest-only payments. Usually that time period is during the first five or ten years of the loan. After that, the loan is amortized for the remainder of its term.
Who might benefit from an interest-only loan:
- Interest-only mortgages can be beneficial for first-time home buyers. Many new home owners struggle during the first year of ownership because they are not accustomed to paying mortgage payments, which are generally higher than rental payments.
- Buyers whose incomes fluctuate because of earning commissions, for example, instead of a flat salary, also benefit from an interest-only mortgage option. These borrowers have the option to pay interest-only payments during slim months and then pay extra towards the principal when bonuses or commissions are received.
The mortgage loan business offers many different options for prospective home-buyers. Once you understand all the various choices available, you can pick loan terms which you can comfortably afford both now and in the future.