There isn’t any such thing as a one-size-fits-all home loan. Homeowners now have more loan options at their disposal than ever before, each of which has different components. To find a loan that best suits your situation, you must understand your options and choose one that accommodates your long- and short-term financial goals and needs.
It’s a big mistake to only consider your present needs. You must look at what your financial situation is now and what you anticipate it will look like in the future. Answering the following questions might help:
Questions to consider
- What does your current financial situation look like — existing debt and income?
- What do you expect your financial situation to look like in the future — income and debt expectations?
- What amount of interest-rate risk and fluctuation can you accept?
- What amount of money do you have to cover upfront costs and use as a down payment?
- How long do you plan to stay in the home?
Once you have an idea of what your financial situation is and will be, you can seek a loan that will work best for your unique situation. For general background on loan options, see Understanding Home Loans and Mortgages. Here are seven of the most common loan types:
1. Fixed-rate mortgage. This mortgage features the same interest rate throughout the life of the loan, so it will never go up or down. That provides predictability for your monthly mortgage payment, which makes the fixed-rate mortgage one of the most popular options. It’s usually a term of 15 or 30 years, though some lenders offer other term lengths.
2. Adjustable-rate mortgage (ARM). This mortgage has an interest rate that can rise or fall. As the rate changes, the monthly payment changes as well. Most ARMs include caps that limit rate increases. ARMs can be attractive if you don’t plan to stay in the home long, because initial ARM rates often start lower than comparable fixed rates.
3. Interest-only mortgage. This mortgage features an initial period when payments cover only interest and none of the principal. The funds that would have gone to principal can be used for other purposes during that term. After the interest-only period ends, payments increase to amortize the loan over the remaining term.
4. FHA loans. An FHA loan involves mortgage insurance provided through a federal program that enables lenders to offer financing to first-time buyers and borrowers with lower down payments. FHA down payments can be as little as 3% and are sometimes rolled into the mortgage, but FHA loans have statutory limits and property eligibility requirements.
5. VA loans. VA loans are backed by the U.S. Department of Veterans Affairs and can offer low or no down payment options, no private mortgage insurance, and competitive rates for eligible veterans, service members, and certain surviving spouses.
6. Subprime loans. Subprime loans are available to borrowers who do not qualify for conventional or government-backed loans because of poor credit. They often require larger down payments and carry higher interest rates, so they are usually best considered a short-term solution while you work to improve credit. For how credit affects eligibility, see Understanding the Impact of Credit Scores on Mortgages.
7. Balloon mortgages. Balloon mortgages have a short term (often up to seven years) but payments are based on a longer amortization schedule (commonly 30 years). At the end of the term, the full remaining balance is due, so you must plan to refinance, pay off the loan, or convert it to another loan type.
When comparing loans, consider the interest rate, fees, required down payment, mortgage insurance, prepayment penalties, and how long you expect to stay in the home. A loan that looks inexpensive over a few years may be costly over the life of the loan if its rate can rise significantly.
Frequently Asked Questions
What is the main difference between a fixed-rate mortgage and an ARM?
A fixed-rate mortgage keeps the same interest rate and payment for the life of the loan; an ARM can change over time, which affects monthly payments.
Can I get an FHA loan with a low down payment?
Yes; FHA loans commonly allow down payments as low as 3%, and in some cases the down payment can be financed into the loan.
When is an interest-only mortgage appropriate?
Interest-only mortgages may suit borrowers who expect higher future income or short-term ownership, but they increase payment risk when principal payments begin.
What is the risk of a balloon mortgage?
The main risk is that the full remaining balance is due when the term ends, so you must be prepared to refinance or pay off the loan then.