Financing Options for Your New Home
There is such an array of mortgages available, how do you figure out which one is right for you? The three main factors in selecting the type of loan are your financial situation, the length of time you intend to own this home, and current interest rates.
When shopping for a loan, you’ll need to know
• The amount of your monthly payment
• The interest rate: adjustable or fixed?
• Closing costs
• If there are prepayment penalties
• Convertibility: can an adjustable rate be converted to a fixed rate at some point?
Despite the sheer volume of mortgages available, they all fit into one of two categories: fixed or adjustable rate.
Fixed rate mortgages
With a fixed rate mortgage, the interest rate on the loan will not change over the life of the loan. Term lengths available include 15 years, 20 years, 30 years, or others, depending on the lender. A fixed rate mortgage offers the stability and predictability of a fixed mortgage payment. If interest rates go up, the buyer is protected from higher mortgage payments. On the flip side, if interest rates drop, the buyer may want to consider refinancing for a lower rate.
Adjustable rate mortgages
An adjustable rate mortgage (ARM) is just that: the rate adjusts. With an adjustable rate mortgage, after a certain period of time (a year, five years, seven years, etc.), your interest rate will rise or fall based on the interest rates in the economy. If interest rates rise, your mortgage payment will increase. If they drop, so will your mortgage payment. These mortgages frequently cap the amount the rate can change each year and over the life of the loan, providing some element of stability. Furthermore, an adjustable rate mortgage frequently starts with an interest rate that is lower than that of a fixed rate mortgage. If you plan to sell your home within five years, an adjustable rate mortgage might be to your advantage. You’ll start with a lower rate, and you’ll sell the house before rates have a chance to increase.
Down payments
Traditionally, conventional loans require a 20 percent down payment. Keep in mind that in addition to the down payment, you’ll need cash for closing costs, prepaids such as taxes and insurance, moving expenses, and utilities. Some lenders offer conventional loans with lower down payments that require private mortgage insurance (PMI). PMI insures the lender against loss in the event that you default on your loan.
Federal programs
First time homebuyers can put as little as three to five percent down on a Federal Housing Administration (FHA) loan, and, in some cases, zero down with a down payment assistance loan such as the Nehemiah program. With an FHA loan, the buyer pays mortgage insurance premiums (MIP). Qualified veterans can apply for Veterans Administration (VA) loans that require no down payment at all. If you intend to finance your home with a VA loan, it is recommended that you get your VA certificate prior to beginning your home search.
Interest Rates and Points
When you talk to lenders about what kinds of loans they can offer, they will usually tell you the interest rate and the points. One point, also referred to as the loan origination fee, is equal to one percent of the loan amount. In general, the lower the interest rate, the higher the points.
Because it can be hard to compare loans that have different points and interest rates, use the annual percentage rate (APR). The APR includes initial mortgage costs (points) and any mortgage insurance so that the rates from different loans are put in the same terms.
Note that the APR for an adjustable rate mortgage will be an estimate, due to the uncertainty of rates in the future.