Types of Mortgages & Which One is Right for You?

Types of Mortgages & Which One is Right for You?

When looking for a mortgage, there are various types available – each with their own advantages and drawbacks that should help you decide which one is ideal for you. By selecting the loan that meets your individual needs, you could lower your down payment and overall interest payments over time.

Mortgages come in three main varieties: fixed rate, adjustable-rate and FHA loans. Each has its advantages and drawbacks that suit different homebuyer profiles.
Fixed Rate Mortgages

When looking for a mortgage, there are several different types available. A fixed rate mortgage is one of the most popular, as its interest rate will remain steady throughout the duration of the loan. Furthermore, this type of mortgage provides stability with regards to monthly payments which may make budgeting much simpler.

Banks, credit unions and other lending institutions typically offer mortgages in a range of terms; 30-year and 15-year options being the most common.

Some borrowers appreciate the security of knowing exactly how much they’ll pay each month for a certain period, while others opt for more flexibility when it comes to financing. If you plan on owning your home long-term, a fixed-rate mortgage could be ideal.

Another advantage of a fixed-rate mortgage is its full amortization, or complete payment coverage when the term ends. This differs from variable-rate mortgages which feature an unpredictable interest rate and various additional payment schedules.

You might not have enough cash to purchase a home in today’s market, so an adjustable-rate mortgage (ARM) could be your solution. These mortgages usually feature lower introductory rates but their value may shift based on market conditions.

For some people, this can be a great deal; however, it could mean paying more in the long run if interest rates increase. Furthermore, if you plan to sell your home before your ARM expires, then you will have to refinance again.

With a fixed-rate mortgage, not only do you enjoy the flexibility and security of an adjustable-rate loan, but you’ll also have peace of mind that your mortgage won’t go into negative equity. This can be especially helpful if you’ve made significant home improvements and seen your property values rise significantly.

Some borrowers choose a fixed-rate mortgage in order to avoid foreclosure. This is because a fixed rate can help borrowers build equity faster than an adjustable-rate mortgage does, leading to greater home equity growth than with an adjustable rate loan alone.

If you’re considering a fixed-rate mortgage, make sure to speak with your lender for more information on how to qualify and which financial goals are best suited for the loan. Be sure to consider factors like interest rate, fees and closing costs before making your decision.

In most cases, you must meet strict credit qualifications to be approved for a fixed-rate mortgage. These criteria typically require at least 620 credit score and an income-to-debt ratio no higher than 43 percent.

You might need to contribute a down payment of at least 5 percent. No matter the amount you borrow, this will reduce your monthly payments and free up cash for other household needs.
Adjustable-Rate Mortgages

Financing your new home comes with many options, including fixed rate mortgages and adjustable-rate mortgages (ARMs). Selecting the correct loan type is essential to ensure success – it should be based on both individual housing needs and budget, as well as your tolerance for financial risk.

Adjustable-rate mortgages (ARMs) offer lower initial rates and payments than fixed-rate mortgages, but those payments may increase after the introductory rate period ends. Therefore, ARMs are ideal for people who plan to move or refinance their loans after several years.

However, ARMs come with some drawbacks that you should weigh before opting for one. Firstly, their complex terms make them difficult to comprehend and follow along with rate caps which limit how much your interest rate can fluctuate during the loan term. Furthermore, an ARM may have hidden fees that you won’t see until after closing.

Be mindful that the initial rate adjustment cap is typically 2 percentage points, and any subsequent adjustments are also usually limited to 2 percentage points. These limits exist to prevent interest rates from becoming too high or low for too long, helping you prevent unexpected charges in the future.

Another major disadvantage of an ARM is that your monthly payment may increase if the interest rate adjusts higher than what you originally agreed to, even in a low interest-rate environment. This makes budgeting your finances much more challenging.

Furthermore, an ARM may require you to pay an upfront mortgage insurance premium, which could significantly increase your monthly payment. While this fee may be beneficial for those looking to save money over time, it could become a major burden for others.

Additionally, you may need to make additional payments during an ARM’s adjustment periods and this could put a strain on your monthly budget. Depending on the term of your loan, these payments may not be enough to cover either all or part of the principal balance or interest due on your loan.

The cost of an ARM depends on the loan type and rate adjustment frequency. The most popular ARMs are 5/5 and 7/1 ARMs, which have a fixed rate for five and seven years respectively, then adjust annually thereafter for up to 25 years.

A 10/1 ARM, on the other hand, features a fixed rate for 10 years and then adjusts annually. To calculate its indexed rate, lenders take an index like prime rate and add on an additional margin which may differ between ARMs.

The total indexed rate on an ARM will always be slightly higher than the original fixed rate, as the lender adds the margin. For instance, if the index is 1.5 percent and the margin is 3 percentage points, then your total ARM rate would be 4.25 percent.
FHA Loans

Home ownership is a significant financial decision, and most buyers require a mortgage to finance the purchase. Selecting the correct type of mortgage is essential for several reasons – such as getting competitive rates and terms.

First-time homebuyers or those having difficulty making large down payments often turn to FHA loans. Unlike conventional mortgages, FHA loans are government backed and offered by lenders who agree to insure the loan. In exchange, these lenders provide low down payment requirements and flexible qualification standards for borrowers.

Depending on your credit score, you may qualify for an FHA loan with as little as 3.5% down. With a higher score, however, 10% down may be possible. If you don’t have enough funds to make a substantial down payment, there are options such as gift funds or other compensating factors which could help you meet eligibility.

FHA loans come with fixed or adjustable interest rates for 30-year and 15-year terms, and they can be refinanced at any time. Furthermore, these loans provide numerous energy-saving upgrades that could potentially lower your energy expenses.

Another advantage of an FHA loan is its lenient qualification standards compared to conventional mortgages, particularly for borrowers with credit issues in the past. Individuals who have gone through bankruptcy can often re-establish their credit and meet FHA criteria in order to be approved for an FHA loan.

Lenders take into account your credit scores, debt-to-income ratio and other risk factors when deciding whether or not they will approve you for an FHA mortgage. This number is calculated by dividing the total amount of monthly debt payments by your gross income.

Are you curious to learn more about mortgages and which ones are suitable for you? Contact Rocket Mortgage(r) to speak with a Home Loan Expert now!

Aside from the FHA mortgage, there are other types of loans that can be used to buy a house. USDA and VA loans offer zero down payments but require upfront fees as well as mortgage insurance premium (MIP). These may be viable alternatives if you lack funds for the down payment or have poor credit.

An FHA 203(k) loan enables you to borrow money for the purchase of a home as well as any necessary repairs or remodels. In some cases, this can be done at the same time you apply for your FHA mortgage.

FHA loans do have their advantages, but they also come with some drawbacks. The biggest is the requirement of an upfront and annual mortgage insurance premium – that’s thousands of dollars that go directly to the lender instead of you.

Avoid these expenses by shopping around for a conventional mortgage. These loans tend to offer better rates and terms, plus you have the option of refinancing your existing loan if ever needed.

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