10-Step Guide to Financing Your Dream Home
Step #6 – Learn About Your Loan Options
Return Tomorrow for Step #7
Learn Your Home Loan Options Before You Decide to Buy
When you need help understanding the various ways you can finance a home, your lender will be the best resource.
But it’s still wise to have an overview of the types of home loans available and how they might fit in with your particular financial plan and your tolerance for risk.
Home Loan Options
Most risky loan programs such as optional payment mortgages no longer exist, but you still have some choices when it comes to deciding which home loan is right for you. You can choose between these options:
Fixed-rate loans: Your principal and interest payment will stay the same for the entire loan term with a fixed-rate mortgage, but your payment may change a little if your property taxes and insurance premiums adjust.
Adjustable rate mortgages: Most ARMs today are hybrid loans with a period of one, five, seven or ten years at a fixed-rate—followed by a period of adjusting interest rates. The initial period has a lower interest rate than a fixed-rate loan, so you can save money on interest—but if you don’t pay the home loan off during that time, you run the risk of higher payments if mortgage rates rise. It’s important to understand how much the home loan can adjust in the future and whether you can afford those payments if interest rates reach the maximum allowed by your loan. ARMs have caps on the amount they can adjust and how often they can be adjusted.
Loan terms: First-time buyers typically prefer a 30-year loan to keep their mortgage payments as low as possible. You can pay less interest over the life of the loan and build equity faster with a shorter loan term such as 20, 15 or ten years. Shorter loan terms have a lower interest rate than 30-year loans, but the payments will be higher because you are paying the balance back more quickly.
Home Loan Programs
In addition to choosing your loan terms, you can choose a home loan program to meet your needs:
FHA loans: A Federal Housing Administration-insured loan protects the lender in the case of a default by the borrower, so lenders are a little more lenient with their qualification guidelines for applicants. FHA loans require a low down payment of 3.5% and are open to all borrowers regardless of whether they have previously owned a home. However, you must pay mortgage insurance with these loans.
Conventional financing: Conventional loans meet the standards of Fannie Mae and Freddie Mac for credit qualifications and your debt-to-income ratio. Most conventional loans require a down payment of 10% to 20%, but some are available with a down payment of just 5%. If you make a down payment of less than 20%, you will have to pay private mortgage insurance (PMI). A conforming conventional loan must be at or below the loan limit for your area.
Jumbo loans: A jumbo loan, needed if you are borrowing an amount above the limit for a conforming loan, requires a larger down payment of at least 20% to 25% and has stricter credit standards because of the higher level of risk associated with a larger loan.
VA loans: Loans from the U.S. Department of Veterans Affairs are only available to veterans, current members of the military and their spouses. Eligible borrowers can buy a home without a down payment and without paying mortgage insurance.
USDA Rural Housing Development Loans: U.S. Department of Agriculture loans don’t require a down payment or mortgage insurance, but they are limited to homes in designated rural areas and to borrowers with up to 115% of the local median income.
When you’re buying a home, it’s essential to make your financing decisions in the context of a long-term strategy for all of your financial needs such as tuition payment for children and retirement.