A comprehensive guide to different mortgage loan types, from FHA to Conventional, learn how to find the right mortgage for you
Confused by mortgages? You’re not alone.
Financing your dream home is complicated and just all-around harder than it should be.
If you don’t get the right financing, you could lose out on your dream home, and all of the hard work you put into finding the perfect home could go to waste.
But, not to worry!
It’s easy to become a mortgage pro.
How, you ask?
With this step by step guide. We’ll walk you through the steps to find the perfect mortgage for your dream home. And, we’ll explain all those confusing industry terms — so you’re prepared when you apply for a mortgage.
Ready to rock the mortgage process? Here are 3 steps to find the right mortgage for you.
First, we’ll explain what a mortgage is.
Before choosing a mortgage, it’s important to have a little background on what mortgages are. A mortgage is a loan from a bank, credit union, or other lender used to buy a home.
When you buy a home, the seller won’t take an IOU that promises to pay them in 30 years. They expect it at the time of closing. Since you likely don’t have enough cash to purchase a house, you need someone who does — which is where a lender comes in.
Your lender purchases your home for you — on the condition that you’ll pay them back (plus interest). This agreement is your mortgage. So, your lender owns your home until you repay the purchase price and any interest you owe. Once you repay your mortgage, you’ll own your home free and clear.
Now that we’ve discussed what a mortgage is, it’s time to find the right one for you.
The first step to finding the best mortgage is to decide on the mortgage term — which is the length of the loan.
A 30-year mortgage is the most common loan term. With this term, you’ll pay back the loan (plus interest) for 30 years. Because you’re paying back the loan over a long period, you’ll have smaller monthly payments (and keep more money in the bank)
But, a longer loan term means you’ll pay much more in interest throughout the lifetime of the loan. And, 30-year mortgages have higher interest rates than shorter-term mortgages.
At the beginning of the mortgage, your monthly payment will mostly go toward interest. So, you’ll build equity (how much of your home you own) slower than with other terms.
Pros of 30-year Mortgage
Cons of 30-year Mortgage
Another popular loan term is 15 years. You’ll pay off your loan over 15 years, so you’ll have a larger monthly payment. With a bigger payment, you may not be able to afford as expensive of a house (so a pool or an entire room for your cat might be out).
With a 15-year loan term, you’ll save thousands on interest during the lifetime of the loan. And, you’ll be able to own your home outright faster than with a longer loan.
The first step in the mortgage process is choosing the right loan term. Either a 30 or a 15-year mortgage could be a good choice — depending on your priorities.
Pros of 15-year Mortgage
Cons of 15-year Mortgage
Like any other loan, you have to pay interest on your mortgage. You can choose between two interest types — fixed and adjustable.
With a fixed interest rate mortgage, you lock in your interest rate when you take out the loan. Whether it’s your first or last payment, you’ll pay the same interest rate.
Having the same interest rate throughout the lifetime of your loan means you’ll have predictable monthly payments. Regardless of what’s going on in the financial world, you’ll have the same mortgage payment every time — different year, same payment.
Fixed-rate mortgages are a good choice if you plan to be in your home for a while. Your interest rate will be higher with fixed-rate mortgages initially than with an adjustable rate (we’ll talk more on that later). Choosing a fixed-rate loan will be a better choice long term.
Pros of Fixed-Rate
Cons of Fixed-Rate
Adjustable-rate mortgages (ARMs) have an introductory mortgage rate that lasts for a few years — like 3, 5, or 7 years.
This initial interest rate is low, which gives you more time to save up. But, after the guaranteed period ends, your interest rate will change each year. So, you could end up with larger monthly payments.
If you know you’ll be relocating, an ARM could be a great choice for you. During the time you’re in your home, you’ll pay less interest than you would with a fixed rate. A caveat to this mortgage type is that, if you can’t sell your home before the interest rate goes up, you could-be in a situation where you can’t afford your home any longer.
Pros of Adjustable Rate
Cons of Adjustable Rate
After determining what term and interest rate work best for you, it’s time to decide on a loan type. There are 2 types of mortgages — conventional and federally insured.
Conventional mortgages are not insured by the federal government. This means that your lender will not recover money from the government if you default on your loan. So, conventional loans are more risky for lenders.
For a conventional loan, you need good credit. Even with decent credit, you’ll likely have a high interest rate. With great credit, you can put down as little as 3% with a conventional mortgage. Anything less than a 20% down payment requires mortgage insurance. Once you’ve paid off 20% of your house, you can cancel your mortgage insurance.
If you have good credit and don’t want to pay a large down payment, a conventional mortgage could be the right choice.
Pros of Conventional Mortgage
Cons of Conventional Mortgage
Federally insured mortgages are backed by the government. When the government insures mortgages, the government will repay some of the loan if the homeowner defaults. This makes it less risky for lenders to lend to people who have lower credit scores or lots of debt.
There are many federally insured mortgage programs, but here are the 3 most popular:
FHA Mortgage: Insured by the Federal Housing Administration, FHA mortgages are easier to qualify for than conventional loans. You can have a credit score as low as 500 and still be approved. And, even with a low credit score, you’ll still get a reasonable interest rate.
You can put down as low as 3.5% of the purchases price. But, with an FHA loan, mortgage insurance is required regardless of the down payment amount. If you put down 10% or more, your mortgage insurance will be canceled after 11 years. If you put down less, you won’t be able to cancel mortgage insurance unless you refinance to a different loan.
With easier to meet requirements, FHA loans can be a good option if you don’t have the credit to qualify for a conventional loan.
Pros of FHA Mortgage
Cons of FHA Mortgage
VA Mortgage: Another popular type of federally insured mortgage, VA mortgages are exclusively for those who are actively serving, veterans, and some widowed spouses.
To qualify for a VA loan, there’s no minimum credit score. Plus, VA mortgages have low interest rates — regardless of your credit score. And, there’s no down payment required. Even with a 0% down payment, you don’t have to pay for mortgage insurance.
While you don’t have to put any money down, you do have to pay a funding fee — which is usually 1.4%-3.6% of the purchase price. You can pay the funding fee either up front or as part of your monthly payment.
If you qualify for a VA loan, the low credit requirements, no down payment, and low interest rates could make a VA mortgage right for you.
Pros of VA Mortgage
Cons of a VA Mortgage
USDA Mortgage: Insured by the United States Department of Agriculture, USDA mortgages aim to help those with low to middle income in rural and suburban areas.
Even if you have little to no credit history, you can still qualify for a USDA mortgage. But, a score of 640 or higher expedites the process. Similar to a VA loan, you can get a mortgage with no down payment. Like an FHA loan, mortgage insurance is required.
To qualify for a USDA loan, you have to live in one of the qualifying rural or suburban areas. And, you can’t make more than 115% of the median household income in your area to qualify.
With low credit requirements and a zero down payment, if you live in a qualifying area, a USDA mortgage could be a good option.
Pros of USDA Mortgage
Cons of USDA Mortgage
If you’re looking for (or have already found) your dream home — congrats!
It’s exciting to be so close to living in your perfect house. Now, the only thing between you and your dream home is finding the right mortgage (which can be a buzzkill).
Between the complicated terms, dizzying array of choices, and seemingly endless requirements, getting a mortgage — much less the right one for you — can seem impossible.
Not to fear, though! If you follow the above simple steps — deciding on your loan term, interest rate, and type — finding the right mortgage will be a breeze. Then, you can start enjoying your dream home (and throw an awesome housewarming party).
Want the strongest offer for when you find your dream home? Upgrade your offer to all cash with Ribbon. You’ll be able to compete with bigger and more experienced buyers. So, you’ll be more likely to secure the right house for you.