Some prospective homeowners assume that the only things affecting their mortgage terms is the value of the property and their own credit score.
In truth, there are more questions a first-time buyer needs to ask themselves than “What is my home worth?” and “How is my credit?” These include such questions as “Where is my home located?” and “How long do I plan to live there?”
Answers to these questions could have a big impact on the type of mortgage that is best for you.
A conventional mortgage loan is one that is not guaranteed by a government agency, but that does conform to guidelines set by Fannie Mae and Freddie Mac, the two federally-backed loan-buying and selling companies in the US. These can be used to acquire a primary home, secondary home, or investment property, and are best for borrowers with good credit and a stable income. Conventional loan lenders typically require borrowers to pay for private mortgage insurance, or PMI, if the price of their initial down payment is less than 20% of the property’s full cost.
Fixed Rate Mortgages
The most common form of conventional home loans, fixed rate mortgages establish a single, unchanging interest rate for the entire lifetime of the loan. This means that a borrower’s monthly mortgage payments will always remain the same, offering a degree of financial predictably that makes budgeting easier. The trade-off is that fixed rate mortgage borrowers usually have higher interest rates and end up paying more overall than borrowers for adjustable-rate mortgages. Fixed rate mortgages are best for borrowers who plan to stay in their current home for a long time.
Adjustable Rate Mortgages
In contrast with fixed rate mortgages, adjustable rate mortgages are conventional home loans whose interest rate fluctuates based on changes in market condition. These changes typically occur at yearly or monthly intervals, depending on the terms of the loan agreement. The benefit of an adjustable rate mortgage is that a borrower could end up paying less interest than originally expected, although the drawback is that they could end up paying more just as easily. Adjustable mortgages, therefore, are best for homeowners who don’t mind the risk and/or don’t plan to stay in their current home for long.
Government Backed Mortgages
Government backed mortgages are loans that are guaranteed by one of three federal agencies, the Federal Housing Administration (FHA), the Department of Veteran Affairs (VA), or the US Department of Agriculture (USDA). These loans help borrowers with lower income and/or subprime credit scores achieve homeownership, albeit under special conditions. For example, VA loans require the borrower to be a former or current member of the armed forces, while a USDA loan requires the borrower’s home to be located in a specified rural area.
Freddie Mac and Fannie Mae guidelines limit the amount of money a borrower can receive through a conventional loan. Mortgages that go beyond those guidelines are called jumbo loans. This helps borrowers afford properties in more expensive areas, at the cost of requiring more documentation, financial assets, and a higher credit score than what is required for conventional loans. Additionally, because they are not backed by Freddie Mac and Fannie Mae, jumbo mortgages represent a higher risk for borrowers and lenders alike.