When buying a home, the type of mortgage you choose will be imperative, as far as how you plan to pay back the loan, the type of financing you need, and what your ultimate plans are for the property in question. Do you need outside assistance? Are you planning to live in the home for a long time? Will you eventually need to refinance? All these questions should be considered at the onset of your mortgage journey.
Since no two homebuyers are exactly the same, there are a multitude of options when it comes to how mortgages are structured. There are also options within those options, but mortgages are mostly distinguished by how the interest is paid, the loan amount in relation to the property value, and the repayment period.
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While any mortgage can be tailored to your personal needs, here are the main types to consider when financing a home purchase.
For the majority of homebuyers, the most common type of mortgage will be of the fixed-rate variety. A fixed rate is one that does not change over the life of the loan, which is reflected on your monthly payment. The repayment period, also known as the mortgage term, can be 10, 15, 20, or 30 years, but the majority of fixed-rate mortgages have either 15- or 30-year terms.
Whether you choose a shorter or longer term depends on how quickly you can repay the loan. With a 15-year term, your monthly payments will be larger, but you will ultimately save on total interest. With a 30-year term, you can lower your monthly payments and stretch out your mortgage, but will pay more in total interest.
Adjustable-Rate Mortgage (ARM)
An ARM starts off similarly to a fixed-rate mortgage, with a fixed interest rate in place for a set period, typically the first five to seven years. After that period, however, the mortgage rate adjusts periodically (based on a corresponding mortgage market index), which will be reflected in your monthly payment — i.e., it can increase or decrease.
Due to their more unpredictable nature, ARMs typically offer lower introductory fixed rates than conventional fixed-rate mortgages. This makes ARMs ideal for homeowners who plan on paying off their mortgage quickly, at a potentially lower rate. ARMs are also a good option for people who think interest rates may go down in the future.
Government Loan Programs
For those in need of lower down payment and credit score requirements when buying a home, there are essentially three types of government backed mortgages: FHA (Federal Housing Administration) mortgage, VA (Veterans Affairs) mortgage, and USDA (U.S. Department of Agriculture) mortgage. These loans are unique in their own ways, but are intended for moderate-to-low income borrowers, veterans, and consumers in eligible rural areas.
FHA mortgages typically require smaller down payments, and do not deter applicants with lower credit scores, which is more common with conventional mortgages. USDA mortgages are intended for moderate-to-low income borrowers in eligible rural areas, with some loans not even requiring a down payment. VA mortgages assist U.S. military members (active duty and veterans), and offer several benefits including no down payment or private mortgage insurance, and caps on closing costs.
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An interest-only mortgage is structured in a unique way, in that a homeowner is only required to make interest payments for an initial period, typically five to seven years. Once that period is over, the borrower will start making monthly payments toward the principal balance on their mortgage.
An interest-only option can be attractive for someone with limited cash flow in the early years, or for someone who plans on eventually selling or refinancing. While this type of mortgage allows borrowers to save money in the short-term, they are not building any equity in their home during the interest-only period and will ultimately pay off their mortgage for a longer time.
Clearly, there are multiple options for homeowners when picking a mortgage and the examples above don’t even cover all of it. There are also jumbo mortgages, which are intended for expensive homes and come with fixed and adjustable rates. Balloon mortgages start off with a typical loan term, but require a large payment to pay off the mortgage as early as five years in.
No matter what type of mortgage you need, it’s important to sort out the details to find the best option for your unique financing needs and living situation. With Fiona, consumers can compare options from multiple top lenders to find out what choice makes the best sense for them.
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