Entering the mortgage world can be daunting, especially for first-timers. With so many options available, an understanding of loan types will lead to informed decision-making. Here, we explore the most common loan types, highlighting their benefits, drawbacks, and features.
Fixed-Rate Loans
Fixed-rate mortgages are some of the most popular home loans. As the name implies, a fixed-rate mortgage has the same interest rate throughout its term, which may last 15 to 30 years. The stability of a fixed-rate mortgage offers predictable payments and protection from interest rate changes. If you need a 30 year mortgage, it’s a great place to start the journey to your forever home.
Fixed-rate mortgages offer stability but at a higher interest rate than other loan types. If rates drop, you’ll miss out on savings unless you refinance.
Adjustable-Rate Mortgages
ARMs or adjustable-rate mortgages offer interest rates that change based on market shifts. Usually, adjustable-rate mortgages start with lower interest rates, which makes them a compelling choice for low-budget borrowers. The uncertainty, however, is a significant drawback. If interest rates increase, you’ll pay more, maybe much more—every month.
Interest-Only Loans
An interest-only mortgage is another option that allows homebuyers to pay only the loan’s interest for a predetermined period, usually five to ten years. Interest-only mortgages result in lower payments and financial flexibility in early term periods, but they come with unique challenges.
These mortgages don’t allow for equity building during the interest-only period. Once that period ends, you’ll be on the hook for the principal and the interest. If you expect a decreased income over the next decade, an interest-only loan may not be the best choice.
FHA Home Loans
For homebuyers who might not qualify for traditional mortgages, FHA or Federal Housing Administration loans offer a great alternative. These loans are backed by the government and help low- to middle-income buyers with lenient credit requirements and lower down payments.
FHA mortgages are ideal for new homebuyers with no savings, but they require PMI or private mortgage insurance that adds to the loan’s cost. Furthermore, government-backed mortgages have limits that don’t cover higher-priced homes.
VA Loans
Active-duty military members, veterans, and those who belong to the National Guard can access VA loans, which are backed by the VA (the Department of Veterans Affairs). These mortgages offer multiple benefits, including no PMI requirement, no down payment, and low interest rates. The biggest drawbacks are that VA loan eligibility is limited to servicemembers and veterans, and there’s a required funding fee that can be rolled into the loan.
USDA Loans
The USDA or Department of Agriculture offers options to encourage home purchases in rural areas. USDA loans are designed for low- to middle-income borrowers and offer benefits like low interest rates and no down payment. The loans have income and geographic eligibility requirements, however, which may limit availability. Mortgage insurance is a necessity that may increase the total cost of a USDA loan.
Jumbo Mortgages
For buyers seeking properties exceeding the FHA’s limits, jumbo mortgages are a viable option. Jumbo loans are typically used for vacation homes and properties in upscale areas, and they come with competitive interest rates for eligible buyers. Credit requirements are stricter than with other mortgage types, and jumbo loans usually require sizable down payments.
Our Take
Selecting a mortgage is a crucial step in the home buying process. Each loan type has unique advantages and disadvantages, and your choice will depend on your plans, risk tolerance, and finances. By considering your options and seeking professional advice when needed, you can find a loan that gets you into your dream home while supporting your financial goals.
