Home Loans- What to Expect

Home loans and mortgages can come in many different shapes and sizes.  Some are government backed, some have adjustable rates, and some have 0% down.   Here is a quick break down of the different mortgage types to make things a little less confusing and help you become more prepared when the time comes for you to get a loan for a new home.  

 

ARM vs Fixed Rate

One of the first decisions you will have to make is to choose a loan that is an Adjustable Rate Mortgage (ARM) or has a fixed rate.  A fixed or adjustable rate refers to the interest rate you will be paying.  In a fixed rate loan, your interest rate will remain the same throughout the life of the loan.  An ARM has an interest rate that will change or “adjust” from time to time. On average, the rate on an ARM will change every year after an initial period of a fixed rate. A hybrid ARM is one that starts off with a fixed interest rate for a certain time period, then it will adjust its rate.  For example, if you have a 7/1 ARM loan, the interest rate will remain the same for 7 years then adjust each year after that for the life of the loan.  

 

(It is important to note that a government backed loan can have and adjustable rate)

 

For a fixed rate loan, you are locked in.  Your payment will not change over the course of the loan.  You have the security of a long term locked in rate.  

 

An ARM can make financial sense for certain homeowners.  Many ARM loans have a fixed period that is between 5 and 7 years.  They also have caps on how much they can go up and down after their initial fixed period. Most caps are around 5% of the initial interest rate.  So, if you had an initial interest rate at 3.5 percent, the most your interest rate could ever be would be 8.5 percent. ARM could be beneficial for the following buyers:

  1. You consider your house a starter home, or plan on moving before you reach the time your loan will adjust.
  2. You will be disciplined and plan to use the savings during the fixed-rate period to accomplish other goals.
  3. You relocate every few years because of your job, and enjoy lower monthly payments because you have no use for a long-term loan.
  4. You plan on retiring and making extra payments to pay the loan down faster, while doing so at the ARM’s lower interest rate.

 

The reality is that many Americans either refinance or move every 5-7 years.  Let’s do some math to see how much money you could save by using an ARM loan compared to a fixed rate in the circumstance that you bought a starter home and moved before the adjustable rate kicked in.  If you bought a home for $200,000 with a 4.5% fixed interest rate, your monthly payment would be $1,013.  If you instead went with an ARM loan at 2.99%, your payment would be $842. In this example, you would end up saving $10,260 in interest over the first 5 years. If you are planning on moving within the time of the fixed rate, then it makes sense to use an ARM.     

 

Government-Issued and Conventional

 

Conventional

A conventional mortgage refers to a loan that is not insured or guaranteed by the federal government. A conventional, or conforming, mortgage adheres to the guidelines set by Fannie Mae and Freddie Mac. It may have either a fixed or adjustable rate.

 

Many homeowners choose a conventional home mortgage because they usually offer the best rates and loan terms, which result in lower monthly payments.  Also, if you are able to put down 20% or more for a down payment, you do not have to pay mortgage insurance.  If you put down less than 20%, you will have to pay mortgage insurance, but it will be less expensive the closer to the 20% down payment you are. Most people choose a fixed rate to help them budget accordingly, knowing what exactly their monthly payment will be.

 

FHA (Government)

FHA loans (Federal Housing Administration) are managed by the Department of Urban Development (HUD), which is a department of the federal government.  You do not have to be a first time buyer to qualify for an FHA loan, as they are available to all buyers. The federal government will insure the loan in case the borrower defaults on the loan.  What makes an FHA loan so attractive is that it will allow you to make a down payment as low as 3.5% of the home’s purchase price.  The negative aspect of an FHA loan is that you will have to pay mortgage insurance for the life of the loan.  This will increase the size of your monthly payment on the loan.

VA Loans (Government)

A great benefit of serving in the military is being able to qualify for a VA loan. The Veterans Affairs (VA) loan types are also guaranteed by the federal government.  What makes a VA loan so attractive is the fact that a borrower can borrow up a 100% of the home value.  They do not have to come up with a down payment to purchase their home. Also, mortgage insurance is not required for the VA loan, saving the borrowers thousands of dollars throughout the life of the loan.   

USDA Loans (Government)

There are also loan types to help rural borrowers who meet certain income requirements.  The United States Department of Agriculture or USDA Loan is offered to residents who live in rural areas who have steady income but may not be able to qualify for a home through conventional financing.  To qualify for an USDA Loan the borrower may not have income higher than 115% of the adjusted area median income.  

What is the Best Loan Type?

This will entirely depend on the family purchasing their new home and what best fits their needs.  Here are some quick reminders of the benefits of a few- with a conventional loan you can put 20% of the home value down and it will allow you to avoid paying any mortgage insurance.  This will save you a lot of money in the long run.  The benefits of an FHA loan is that you can get into a home with only 3.5% down on the home value.  This makes it a lot easier to save up for a home and a more common loan type for a first time buyer.  A VA has some of the best options, but you do have to be a veteran to qualify for the loan.  The best thing for a family to do is to sit down with a local lender and look at all the options.  Many lenders will offer different incentives and deals to get you to work with them.  They may offer lower interest rates, more credits towards your closing cost, or down payment assistance.  

Get in a home for 0% down.

 

There are ways to get into a home with 0% down.  The program is called CalHFA.  In essence, you take out a second loan in conjunction with the standard FHA loan to cover your down payment, resulting in paying 0% down.  Low income borrowers may be eligible to have the second loan forgiven without repayment.  You do have to have a minimum FICO score of 640 to qualify for the CalHFA.  This will result in a higher monthly payment, but can be beneficial to people who may be struggling to come up with the down payment.


There are many more options for loans, but this information is a great basic tool to help you understand a little bit more about home loans before you go get started home searching.  We strongly recommend talking to lenders and doing your due-diligence before you decide on which home loan is right for you.  Shop around and see what lenders are offering.  See if they can beat other interest rates, and ask if they may be able to help with closing cost.  The more you understand about the process, the less stressful it will be and will help make buying a home a smooth transaction.