How to determine which mortgage is right for you:
Know the difference between interest rate vs. annual percentage rate, APR.
It’s easy to confuse a mortgage interest rate and APR, but they’re quite different. The interest rate is the cost of borrowing money for the principal loan amount. It can be variable or fixed, but it’s always expressed as a percentage. An APR (annual percentage rate) includes the mortgage interest rate plus other costs such as broker fees, discount points and other lender fees, expressed as a percentage. APR is often higher than your interest rate.
What are the different types of mortgages?
Fixed-rate mortgages are the most common mortgage type. The interest rate remains the same for the life of the loan. With a fixed-rate mortgage, your monthly payment won’t change (outside of property taxes, insurance premiums or homeowner’s association fees).
Adjustable-rate mortgages, or ARMs, have an initial fixed-rate period during which the interest rate doesn’t change, followed by a longer period during which the rate may change at preset intervals. Generally, interest rates are lower to start than with fixed-rate mortgages, but they can rise, and you won’t be able to predict future monthly payments.
Jumbo mortgages are conventional loans that have non-conforming loan limits. This means the home prices exceed federal loan limits. For 2020, the maximum conforming loan limit for single-family homes in most of the U.S. is $510,400, according to the Federal Housing Finance Agency. Jumbo Mortgages are more common in higher-cost areas and generally require more in-depth documentation to qualify.
Government-insured loans are backed by three agencies: the Federal Housing Administration (FHA Mortgages), the U.S. Department of Agriculture (USDA Mortgages) and the U.S. Department of Veterans Affairs (VA Mortgages). The U.S. government isn’t a mortgage lender, but it sets the basic guidelines for each loan type offered through private lenders.
Choosing the Right Mortgage Program
Narrowing your mortgage choices can be difficult. Here’s a list of pros and cons of each of the options mentioned earlier to help you decide.
- Rates and payments remain constant, despite interest rate changes.
- Stability makes it easier to budget.
- Simple to understand.
- Interest payments tend to be higher.
- To get a lower rate, borrowers have to refinance the loan — and pay closing costs again.
|Who it’s best for Borrowers who plan to stay in a home many years and want predictable, stable payments at the same interest rate for the life of the loan.
- Feature lower rates and payments early in the loan term.
- May qualify for more house because payments are lower (initially).
- Help you save and invest more money with a lower payment early in the loan.
- Rates and payments can rise over the life of the loan.
- Higher rates — and payments — when loan resets can be hard to manage.
- ARMs are difficult to understand.
- Lenders have much more flexibility to customize.
|Who it’s best for Borrowers who don’t plan to stay in a home for more than a few years — especially when rates are higher.
- Can be used for a primary home, second home or investment property.
- Overall borrowing costs tend to be lower than other loan types.
- PMI is cancellable once you’ve gained 20 percent equity.
- Put as little as 3 percent down for agency loans.
- Minimum FICO score of 620.
- Debt-to-income ratio of 45 to 50 percent.
- PMI typically required if your down payment is less than 20 percent.
- Significant documentation required to verify income, assets, down payment and employment.
|Who it’s best for Borrowers with strong credit, a stable income and employment history, and a down payment of at least 3 percent.
|Government-insured mortgages [ FHA, VA USDA ]
- More relaxed credit requirements.
- Don’t require a large down payment.
- Open to repeat and first-time buyers.
- Mandatory mortgage insurance premiums that cannot be canceled on some loans.
- Higher overall borrowing costs.
- May require more documentation to prove eligibility.
|Who it’s best for Borrowers who have low cash savings, less-than-stellar credit or can’t qualify for a conventional loan. VA loans tend to offer the best terms and most flexibility compared to other loan types for military borrowers.
- Borrow more money to buy a home in an expensive area.
- Interest rates tend to be competitive with other conventional loans.
- Down payment of at least 10 to 20 percent is needed.
- Minimum FICO score of 660, but average is typically 700 or higher.
- Maximum DTI ratio of 45 percent.
- Must have significant assets (10 percent of the loan amount) in cash or savings accounts.
|Who it’s best for Affluent borrowers purchasing a high-end home who also have good to excellent credit, high incomes and a substantial down payment.