Today there are many choices for a home mortgage. And that’s great for home buyers. You can customize your loan based on how much money you have to put down at closing, your credit score, how long you want the loan to last, if you want the interest rate to start out lower and possibly change and more. A good loan professional will listen to your needs and share options for your situation.
If you’re not sure how much you can afford to pay for a mortgage or if you can even qualify for a mortgage, talk to a lender about getting pre-qualified. Learn more about pre-qualification
When you’re deciding on a loan type, consider these key questions:
- How much cash can I pay up front for a down payment and closing costs?
- How long do I expect to hold the loan?
- Should I choose a lower interest that can change over time, or should I get a fixed interest rate that won’t ever change?
1. How much cash can I pay up front?
How much cash you can pay up front to buy a home will affect how your loan is structured. In most cases, you need at least 3.5% of the purchase price for a down payment. Besides a down payment, you will also need to pay closing costs.
Closing costs include things such as loan origination fees, underwriting fees, property and other taxes, title costs, homeowners insurance, an appraisal and mortgage insurance fees if you’re putting down less than 20% of the purchase price. Closing costs vary but commonly range from 3%-5% of the purchase price.
Some states allow new homebuyers to add a portion of closing costs to the loan. However, in most cases you will need enough cash to cover the closing costs, and you cannot add closing costs to the loan amount.
Tip: In some cases, you can get seller credits to help cover closing costs. For example, if you’re buying a home for $400,000 and want $10,000 for closing costs, you could offer to pay $410,000 for the home and have the seller credit $10,000 back towards your closing costs. But there’s a catch; the home must appraise for $410,000 for the lender to allow the higher loan amount, and the seller must be willing to work with you. It may be harder to find a flexible seller in a seller’s market. (A good real estate agent can help you negotiate this strategy.)
Tip: Another potential way to pay closing costs is with a so-called “no-cost” loan. With this type of loan, you can choose to take a higher interest rate but in return, get a credit back from the lender to cover the closing costs.
2. How long do I expect to hold the loan?
A mortgage can allow you from 5 years to 30 years to repay the loan. The longer the loan term, the lower your monthly payment. However, you end up paying more interest overall with a longer term. Consider how long you expect to own the home, because you may be able to get a lower interest rate by choosing a shorter-term loan.
If you plan to keep the loan for many years, you may want to lock in your interest rate with a fixed rate.
Many buyers choose the security of a fixed interest rate that will never change, such as a 30-year fixed mortgage. You’ll always know how much you’ll be paying for principal and interest in your monthly payment. But be aware your monthly payment will still increase over time if you have an escrow account because your property taxes and homeowners insurance portions inevitably increase.
You can also choose a shorter term if you want to pay your loan off faster (but with a higher monthly payment). A 15-year mortgage will have a lower interest rate than a 30-year mortgage.
For example, a $300,000 mortgage at 3.75% interest for 15 years fixed would cost you $2,182/month for principal and interest.*
A $300,000 mortgage for 30 years fixed at 4.25% interest would cost $1,476/month for principal and interest.*
Your payment for the 30-year mortgage would be $706 less per month.
*These numbers are for example only and may not represent actual, current interest rates for which you could qualify. Please note your mortgage payment will also likely include a portion for taxes and insurance (in “escrow”), which can add hundreds of dollars per month to your payment.
Estimate your payment for a property you’re interested in
3. Should I choose a lower interest that can change over time, or should I get a fixed interest rate that won’t ever change?
Getting the lowest interest rate is always the best choice, right?
Well, not always. It depends on the situation. The lowest interest rates may come with high closing costs, require a large down payment and require excellent credit. And how long you expect to keep the loan is a factor to determining the best loan for your situation.
If you see mortgage ads for a super low interest rate, that rate is probably for an ARM, or adjustable rate mortgage. The initial low interest rate can adjust over time, after being fixed for a certain amount of time. The interest rate could go down, but it could also increase, so there is some risk involved.
An ARM is amortized over 30 years, meaning the total payment schedule is spread out over 30 years. But the interest rate may go up or down at certain times, which vary based on your loan.
Let’s look at some examples. The first number shows how long the initial interest rate is fixed; the second number shows how often the interest rate can change:
- 5/1 ARM: The initial interest rate stays fixed for 5 years; after that, the interest rate can adjust annually
- 5/2 ARM: The initial interest rate stays fixed for 5 years; after that, the interest rate can adjust every 2 years
- 7/6 ARM: The initial interest rate stays fixed for 7 years; after that, the interest rate can adjust every 6 months
- 10/6 ARM: The initial interest rate stays fixed for 10 years; after that, the interest rate can adjust every 6 months
There is a floor and a ceiling for how much the interest rate can change. For example, with a 2% limit, a loan that starts at 2% could go down to 0% or up to 4%. Usually, the maximum change allowed is 5%. It is most common for the rate to adjust annually. And it’s not guaranteed to change.
If you plan to sell or do a cash-out refinance on a property after just a few years, an ARM can be a good choice because you’ll save money with the lower initial interest rate.
Tip: You can look at the APR of any loan to directly compare total loan costs against other loans.
Tip: The higher your credit score, the lower the interest rate you can get, which will save you money over the long term. The interest rate varies by your credit score, your down payment and loan amount. It’s smart to check your credit three to six months before you apply for a loan and try to boost your credit score to get the best loan terms possible. Ask us for help in boosting your credit score.
Your loan officer will analyze your loan application to consider 3 things (sometimes called the 3 C’s) to generate a pre-approval letter:
- Capacity to repay
- Capital (or cash)
- With your authorization, a loan officer will pull your credit. The higher the credit score, the better the terms you’ll be offered. Typically, lenders have options for scores above 580.
- Capacity is your ability to make the monthly loan payments. A loan officer will look at your gross monthly income and your debts. This analysis can be very simple if you’re a W-2 employee, or it can get a little more complicated if you’re self-employed. A good loan officer can help you through that process.
- And third, a loan officer will look at your capital or cash, which is how much money you have set aside for a down payment, closing costs and reserves that the mortgage company might require. The loan officer will verify those funds through bank statements, retirement funds or other sources of capital.
After verifying your credit, capacity and capital are sufficient, the loan officer will write you a pre-approval letter, which is an offer (but not a guarantee) to lend you money based on that information.
A good loan officer will also run Fannie Mae or Freddie Mac’s automated underwriting software to try to generate preliminary underwriting approval. This step makes a pre-approval letter even stronger.
When you work with a good loan officer for pre-approval, your offer on a house can be as good as cash, because they’ve verified that you will very likely qualify for the loan.
Tip: A pre-approval letter is usually valid for 90 days. After 90 days, you can talk to your loan officer, and they can update your letter if your financial situation hasn’t changed.
Learn more about the entire loan process.
Common Mortgage Loan Types
- Conventional loans – For well qualified borrowers
- Federal Housing Administration (FHA) loans – For less qualified borrowers
- Veterans Administration (VA) loans for qualified active-duty military and veterans – Often considered the best loans, if you can qualify through military service
- USDA loans – For rural areas
Conventional loans are by far the most common loan type. If your credit profile is strong (and you don’t qualify for a VA loan), consider getting a conventional loan. You can put down as little as 3% of the purchase price with a credit score of at least 620, depending on certain factors.
There is an additional cost to your monthly payment in the form of private mortgage insurance (PMI) if you put less than 20% down. You, the borrower, are required to pay for this insurance policy in case you default or stop paying on the loan. But the good news is you can have this extra cost removed when you build up 20% equity in the home, unlike an FHA loan that will always include PMI.
You can later remove PMI by refinancing into a brand-new loan. You can also have PMI removed from your existing loan by paying down your loan enough that you have 20% in equity or through your property appreciating by 20%. You would need to pay for an appraisal to verify the higher property value, and then you can request that the lender remove the PMI from your monthly payment.
Tip: Equity is the dollar difference between how much your property is worth and how much you owe on it. For example, if your home is worth $200,000 and you owe $150,000, you have $50,000 in equity.
You can use conventional loans for a second home or investment property with up to 4 units, not just for a primary residence. Conventional loans can offer the choice of an ARM or a fixed interest rate loan. And some types of conventional loans can be used for “fixer upper” properties.
You can also get a larger loan amount, based on your qualifications of course, called a jumbo loan. (Loan size limits vary by county.)
If your credit is less than perfect, an FHA loan may be right for you. FHA loans may require as little as 3.5% of the purchase price as a down payment. You can get approved with a lower credit score than other types of loans, making it easier to qualify.
Interest rates for FHA loans are low, but closing costs are typically higher than other loan types. Closing costs include an up-front mortgage insurance premium of 1.75% of the loan amount, and that’s in addition to the monthly PMI payment. (That up-front premium is the one closing cost that can be rolled into the loan amount; other closing costs must be paid out of pocket.)
FHA loans ALWAYS have PMI. If your equity has increased enough that you don’t think you need to pay PMI anymore, you would need to refinance into another type of loan such as a conventional loan.
These loans are available because they are backed by the government. The government wants you to own a home–it’s good for our nation and economy. But there are certain rules that apply.
An important rule is that the property must be in good condition, for safety reasons. Properties that need more repairs may not qualify, so that is a problem if you want to buy a property that you could fix up.
And FHA loans can only be used for a primary residence, not an investment property. But you can use an FHA loan to buy a duplex, triplex or 4-plex, as long as you live there for at least one year. (And you can put down as little as 5% for one of these small multi-units.)
Tip: You’ll need a credit score of at least 580 to qualify for 3.5% down. You can still qualify with a minimum credit score of 500 (in addition to other factors), but you’ll need to put down 10% in cash at closing.
In some states and counties, first-time homebuyers with low to moderate income can qualify for grants. Please ask us to help you find grants for which you might qualify.
If you or your spouse have served in the military, congratulations, you may qualify for a VA loan! VA loans are often considered the best loans for homeowners. VA loans offer some of the lowest, fixed interest rates–lower than a conventional loan.
You can get a VA loan with $0 down! If your credit score is below 580, you will need to put 10% down (with a minimum credit score of 550).
VA loans do not have PMI. There is, however, a VA funding fee; the amount varies a bit depending on some factors, but it can be rolled into the loan amount. (Disabled veterans are exempt from the funding fee.) There are loan limits for VA loans, and they can only be used for a primary residence.
Tip: To prove you qualify for a VA loan, you’ll need to get a Certificate of Eligibility (COE) from the Department of Veterans Affairs. Veterans will also need to provide DD Form 214. You can save some time later by requesting these forms early on.
Want to own more properties?
Each borrower may qualify for up to 10 total conventional and FHA loans. (A married couple can have 20 loans combined, 10 each in their own name if they can qualify.)
If you’re a real estate investor looking to buy more properties or commercial properties, or you’re self-employed or can’t meet the lending criteria for the loan types we have discussed, don’t worry. There’s another type of loan called a “nonQM,” or non-qualified mortgage, that can open up more options. We can help you with those, too.
Helping You Make the Right Choice
If you’re not 100% clear on the different loan types and which one is best for you, then you’re perfectly normal. That’s why we’re here! We are the loan experts and will guide you through all your options to help you feel confident you’re making the right choice.