Getting a home loan is probably one of the biggest on-going expenses that you'll ever have to make in your life. This is why it's so important to choose the right kind of home loan. After choosing, the next most important step is to shop around to find the best mortgage rates in the market.
To help you find the right kind of home loan for your unique situation, we at GET.com will show you the main types of mortgage that are available in the US and explain the pros and cons of each type.
In these two categories, there are many variations. Understanding the basics of each one will help you make a smarter choice when choosing a mortgage.
If you are a first time homebuyer who does not have enough money to pay a 20% down-payment on a home loan, you may want to consider applying for a FHA loan. FHA stands for Federal Housing Administration, which was created by the US Congress in 1934 to help people with low income become eligible for a home loan.
Technically, FHA loans are not mortgages, but rather an insurance on loans by FHA-approved lenders. That means that the FHA does not lend money, it insures the loan to cut the lender's risk in case of the borrower failing to pay. The FHA will pay the lender in the event of a homeowner failing to pay. Since FHA insures the loan, it makes it easier for people with low income to be accepted by lenders.
Pros and Cons of FHA Loans
The main advantage is that you don't have to pay a standard 20% down payment. Down-payments on FHA loans can be as low as 3.5% of the purchase price! Since the initial investment is minimal, it makes it easy for college students, newlyweds, and first-time home buyers to get a loan. However, paying a low down-payment also means that you will end up paying more interest than if you paid a conventional 20% down payment.
An FHA loan is also an alternative for people who have tried to get a conventional home loan but have been denied. If you have suffered bankruptcy or a foreclosure and can't apply for a conventional loan, you may still be eligible for an FHA loan. There are also no minimum credit score requirements, and you can apply even if you have no credit history.
On the downside, you must pay the mortgage insurance premium (MIP). There are two kinds, and you have to pay both. One is the upfront mortgage insurance premium which is financed into the mortgage (1.75%), and the other is the annual MIP (which you pay monthly). If you can afford to make a larger down-payment, then you should consider a conventional mortgage loan since you will pay less interest over time.
FRM Loans (Fixed-Rate Mortgages)
Fixed-rate mortgages are the most popular type of mortgage loans in the US. They are called ‘fixed-rate' because they have a fixed monthly payment. This is very convenient because it lets you plan your budget with complete accuracy.
Pros and Cons of FRM Loans
FRM loans are a good option if current rates are low (like right now), or if you believe that interest rates will rise in the future. With a fixed-rate loan, you forego the risk of paying more when interest rates rise. FRM loans are also easy to understand, so they are a better option for first-time homebuyers. If you plan on staying in your new home for a long time, a fixed-rate mortgage may be a wise option.
The downside, is that FRM loans tend to be more expensive than ARM loans because of the lack of rate break or early-on payment. You also won't benefit from dropping interest rates unless you refinance - which will cost money and take time. FRMs also tend to be almost identical to each other, lacking the customization of ARM loans.
ARM Loans (Adjustable Rate Mortgages)
ARM loans adjust with the market - meaning that you will pay less if the rate goes down, and more if it goes up. Borrowers choose ARM loans because they generally have lower initial payments than FRM loans. On the flip side, since rates adjust with the market, it can also be risky if rates were to rise steeply. Although, if rates drop, you can benefit from lower premiums!
Pros and Cons of ARM Loans
The advantage of getting an ARM loan is benefiting from lower initial payments. The disadvantage is that later on you are exposed to a risk of higher payments. Make sure you can afford to pay the ARM loan if rates were to suffer a steep rise. ARMs are also more complicated than fixed-rate mortgages because you must be aware of many factors at once. If you are buying your first home, or you prefer to know exactly what you have to pay each month, then you should consider a less risky type of home loan - a fixed-rate mortgage.
VA stands for Veteran Affairs, and a VA loan is a mortgage loan program by the US Department of Veteran Affairs. It is designed to help veterans, active military, and some other home buyers to obtain home financing. Just like other conventional loans, VA loans are based on credit history, income, assets and debt. To be eligible for a VA loan, you need a COE (certificate of eligibility) from Veteran Affairs. To apply for one, borrowers must be a veteran or an active member of the armed forces (and meet certain criteria). Widowers and widows may also be eligible if their spouse suffered a service-related death. And since 1992, Reservists and National Guards who received an honorable discharge and served for 6 years or more may also qualify.
Pros and Cons of VA Loans
VA loans are available from most lenders and they don't require any down-payment - this the major advantage over conventional loans! Also, the appraisal fees and closing costs are limited by the government, and lenders are not allowed to charge private mortgage insurance. This is a great advantage and can amount to thousands of dollars saved over time. VA loan rates are in line with most conventional loan rates because they also follow the market.
The main disadvantage is that you must pay a one-time funding fee, which is generally around 2% of the home price. If you choose, you can finance the fee in the VA loan. The fee ranges from 0%-3.15%, and eligible borrowers can borrow up to 103.15% of the sales price or reasonable value of the home (whichever is less).