Understanding your options gives you the power to make the best choice…
For today’s home buyers, choosing the right mortgage is as important as choosing the right home. There are a variety of loan programs, loan terms, loan rates and loan options available today. Sorting through the choices to find the best loan for you can be daunting. By having a basic understanding of the options available and the meaning of some of the key terms, you will have the confidence to make a choice that best fits your needs.
Mortgage loans can be classified and categorized a few different ways. We’ll start with how the loans are structured for repayment. Generally speaking, they fall into two categories; fixed rate and adjustable rate mortgages.
Fixed Rate and Adjustable Rate Mortgages
With a fixed rate mortgage, the interest rate remains the same for the entire term of the loan. The most common loan term is 30 years and is referred to as a “30 Year Fixed” mortgage. 15 year terms are also popular and other term lengths can be found ranging from as few as 10 years to as long as 50 years.
The primary advantage of a fixed rate loan is the certainty of knowing your payment amount and knowing that it will not change. The disadvantage is that this certainty comes with a slightly higher interest rate than the alternatives.
These loans are best suited for buyers who plan to stay in their new home for the foreseeable future and who want security of knowing what their payment will be for the length of the loan.
The second category of loans are adjustable rate mortgages, also known as ARM’s. As the name implies, the interest rate on these loans is adjusted periodically based on a specified financial index. Commonly used indexes include the London Interbank Offered Rate (LIBOR), the Cost of Funds Index (COFI) or 1-Year Treasury Notes.
These loans typically have a low starting rate therefore lowering your monthly payment compared to a fixed rate mortgage. However, because the rate is tied to an index that fluctuates based on market conditions, there is risk of your monthly payment moving higher should the index move up.
There is also a third option called a hybrid. These loans combine elements of both a fixed rate and an adjustable rate mortgage. They start off as a fixed rate for a set number of years and then convert into an adjustable mortgage.
An example of such a loan is a 5-Year ARM or a 5/1 ARM. This means the loan’s interest rate is fixed for the first 5 years then it becomes adjustable. The advantage of this loan is that the fixed rate period of the loan usually has a lower interest rate than a 30 Year Fixed mortgage. For buyers who plan to stay in their new home for 5 years or less, this can be a more affordable yet less risky alternative.
Variations on the hybrid loans, such as a 3/1 ARM or 7/1 ARM, alter the length of the fixed part of the loan. In these instances, the fixed period would be 3 years and 7 years respectively.
FHA and VA vs. Conventional Mortgages
A second way to categorized loans is by whether or not they are government insured. The two most common types of government insured loans are FHA (Federal Housing Authority) and VA (Veteran’s Administration). It’s important to understand that these loans are not made by the government. The government’s role in these loans is to guarantee their repayment to the lender in the event of a default. Because of the added security this government backing provides, the underwriting rules are more relaxed and many people that would otherwise not qualify for a loan are able to obtain one. Essentially, you still go through the same process as a conventional mortgage – just with some additional paperwork!
The key question to ask is, do you qualify for an FHA or VA loan? The fact is many people do. In particular, first time buyers can often qualify for an FHA loan. There are many factors that determine qualification and if a government program is even right for you.
Conventional Mortgages – Conforming or Jumbo
Conventional mortgages come primarily in two varieties, conforming and jumbo. This distinction refers to the loan amount. The top end of the conforming limit starts at $417,000. So if your loan amount (not the purchase price of the home) is below that number, you would be getting a conforming loan. The specific limit varies based on where you are purchasing and in some areas is as high as $802,000. (And even higher in places like Hawaii)
The distinction between conforming and jumbo is made to assist with underwriting. Jumbo loans are considered riskier because of the higher loan amounts and therefore come with higher rates.
That’s a lot of information! Hopefully you’ll find it useful as you navigate your way through the loan process. At least the next time you’re talking with someone about ARM’s, FHA’s and Jumbo’s, you’ll have an idea of what they’re talking about.
Please contact us if we can be of any assistance.