A new home can be the biggest purchase of your life. Before you start looking for the right home, you need to examine your mortgage options if you want to finance your purchase.
However, not all home loans are created equal. So, by doing your research before proceeding, you can choose the option that best suits your financial situation and potentially puts more money in your pocket. Also, you know what to expect in terms of policies when you apply.
Traditional loans that are not backed by the federal government come in two flavors: compliant and noncompliant.
- Compliant Loans – As the name implies, “compliant” loans are loans that meet the standards set by the Federal Housing Finance Agency (FHFA), including credit, debt, and loan size. The equivalent credit line through 2022 is $647,200 in most areas and $970,800 in more expensive areas.
- Noncompliant Loans – These loans do not comply with FHFA standards. Instead, they cater to borrowers looking to buy more expensive homes or people with unusual credit profiles
Advantages of Traditional Loans
- Can be used as a primary residence, second home or investment property
- Despite slightly higher interest rates, overall borrowing costs tend to be lower than other types of mortgages
- Once you are at 20% equity, you can ask your lender to cancel Personal Mortgage Insurance (PMI), or remove it by refinancing
- Only 3% of loans guaranteed by Fannie Mae or Freddie Mac can be repaid
- Sellers can contribute to closing costs
Disadvantages of Traditional Loans
- Typically requires a minimum FICO score of 620 or higher (refinancing is also true)
- Higher down payment than some government loans
- The debt-to-income ratio (DTI) must not exceed 43% (50% in some cases).
- If your down payment is less than 20% of the sale price, you may be required to pay PMI
- Important documents required to verify income, assets, savings and employment
Who should get a traditional loan?
If you have good credit and can afford a substantial down payment, a conventional mortgage may be the best option for you. The classic 30-year fixed-rate mortgage is the most popular option for homebuyers.
Adjustable rate mortgage
If you have an adjustable-rate mortgage (ARM), your payments may fluctuate more than on a fixed-rate mortgage. Each ARM loan agreement describes how often the interest rate can be adjusted, how much it can be adjusted in one step, and how much it can be capped for a lifetime.
Why Home Buyers Use This Type of Loan
- Interest rates are usually lower than fixed rate loans – at least at the beginning of the semester.
- Some homebuyers use an ARM at the outset of their loan to lower their repayments. This is good for them if they plan to resell or refinance their home, especially before major ARM customizations.
- ARMs can be more confusing than fixed rate loans.
- During the life of the loan, your repayments can change significantly, making it more difficult for you to afford your mortgage in the future.
Mortgages guaranteed by government programs
VA loans can be very lucrative if you are a veteran or active duty military. Regulated by the Department of Veterans Affairs, these home loans typically offer the best rates of any type of mortgage. VA loans don’t require a down payment (although sometimes it’s good to put as much down as you can). If you have a low credit score or bad credit information on file, it may be easier to get approved for a VA loan than other types of mortgages.
FHA loans, regulated by the Federal Housing Administration, are designed to make homeownership easier for those who might not qualify because they don’t have the best credit history or haven’t managed to save a large down payment. FHA loans tend to be more expensive than traditional loans, but you may be able to get approved with a credit score as low as 500 and a down payment of as little as 3.5%.
If you live in a rural area and your income is modest, the USDA loan program may be right for you. You don’t need a deposit (but you may still want to pay as much as you can). You may also need to pay extra for mortgage insurance, but even then, these loans are usually less expensive than FHA loans.
Why Home Buyers Use This Type of Loan
VA loans are often the cheapest mortgage option for active duty and retired military personnel.
FHA and USDA loans allow people who might not qualify for a traditional mortgage due to credit issues or lack of savings for a down payment to own a home.
These loans may take longer to complete as the property needs to be inspected and loan requirements met.
USDA and FHA loans are often more expensive than traditional loans for people with good credit and higher down payments.
Fixed rate mortgage
With a fixed-rate mortgage, the interest rate remains the same throughout the life of the loan, which means your monthly mortgage payment remains the same throughout. Term loans typically have a term of 15 or 30 years, but some lenders allow borrowers to choose any term between 8 and 30 years.
Advantages of Fixed Rate Mortgages
- Monthly principal and interest payments remain the same throughout the loan term
- Easier to budget for housing expenses on a monthly basis
Disadvantages of Fixed Rate Mortgages
- When rates drop, you have to refinance to get a lower rate
- Interest rates are usually higher than those on adjustable rate mortgages (ARMs)
Who should get a fixed-rate mortgage?
If you plan to live in your home for at least five to seven years and want to avoid potential changes in your monthly payments, a fixed-rate mortgage is for you.