Unless you have enough money to pay for a house yourself, you'll need a mortgage loan. A mortgage is a loan you take out to finance the purchase of your home. It is also a legal contract stating that you promise to make a monthly payment until your loan is paid off.
Today, there are hundreds of different programs to choose from, but don't let that overwhelm you. Most of the home loans are variations of a fixed-rate mortgage and adjustable-rate mortgage. Knowledge of how these mortgage programs work will help you to understand the majority of available loan options. You may qualify for a new loan without even selling your current home. It's simple to run the numbers for yourself on our Mortgage Calculator.
Today, there are hundreds of different programs to choose from, but don't let that overwhelm you. Most of the home loans are variations of a fixed-rate mortgage and adjustable-rate mortgage. Knowledge of how these mortgage programs work will help you to understand the majority of available loan options. You may qualify for a new loan without even selling your current home. It's simple to run the numbers for yourself on our Mortgage Calculator.
Home Purchase Loans
With a fixed rate mortgage, payments for the interest rate and the principal remain fixed over the life of the loan. As a result, monthly loan payments stay the same over the life of the loan. Taxes, however, may change according to your local or state tax laws.
Advantages:
- The interest rate stays the same-it doesn't go up even if rates in the market do
- Monthly payments of principal and interest don't change
- May be a good choice for homebuyers who plan to own their home for a long time
- May cost more than other loan types-the interest rate is often higher than rates for adjustable rate mortgages
- A long-term loan may not be suitable for homebuyers planning to move or refinance within 5 to 7 years
Fixed rate mortgages are available10-year, 15-year, 20-year, 30-year and 40-year amortization terms.
Which Term Will Work Best for You?
A Shorter Term:
- May be good for homebuyers planning to own a home for a shorter time
- Loan is paid off more quickly
- Generates less interest over the life of the loan, so it costs less overall
- Translates into higher monthly payments
- Builds equity faster
- May be good for homebuyers planning to own a home for a longer time
- Loan is paid off more slowly
- Generates more interest over the life of the loan, so it costs more overall
- Translates into lower monthly payments
- Builds equity more slowly
Adjustable-Rate Mortgages
With an adjustable rate mortgage (ARM), the interest rate is fixed for a certain number of years. Afterwards, the rate goes up or down periodically based on an economic index, which lenders use as a benchmark for interest rate adjustments.The initial fixed rate, or "teaser rate" of an ARM is usually lower than the rate of a fixed rate mortgage. After the initial period, the rate adjusts based on the rate index used by the lender. With every rate adjustment, the mortgage payment will change.
The amount of time between rate adjustments is called the adjustment period. Many ARMs have a one-year adjustment period, meaning that the interest rate will adjust every year. Because rate adjustments can be unpredictable, most ARM programs offer a rate cap that limits the amount the interest rate can increase each year or over the term of the loan. The term for most ARMs is 30 years.
Advantages:
- The teaser rate keeps initial monthly payments low, which may enable homebuyers to consider a more expensive home than might be possible with a fixed-rate mortgage
- If interest rates go down, the homebuyer will have lower payments
- May be a good choice for homebuyers who relocate often or who plan to move after a few years (e.g. homebuyers in the military or those buying their first home)
- May be suitable for homebuyers planning to refinance within 5 to 7 years
- May be appropriate for homebuyers who like the initial payment stability, but can afford later adjustments in interest
- After the initial fixed rate period, the rate becomes adjustable and monthly payments could increase if interest rates go up
- May not be the optimal choice for homebuyers on a fixed income who may only be able to afford monthly payments during the low teaser rate period
- May not be the best choice for homebuyers who plan to stay in their home for longer than the teaser rate period
An adjustable rate mortgage is often written as a pair of numbers-for instance, "3/1 ARM", "5/1 ARM" "7/1 ARM", or "10/1 ARM". The first number indicates the number of years the interest rate will remain fixed. The second number indicates the adjustment period of the loan-how often (in years) the interest rate will adjust after the initial fixed-rate period.
Example: For a 3/1 ARM loan, the interest rate is fixed for the first three years. Starting in the fourth year, the rate adjusts every year. Payments are subject to change every year for the remainder of the loan.
Interest-Only ARMs
With an interest-only ARM, monthly payments for the initial period of the loan are made only on the interest. During this time, the interest rate is fixed.
Once the interest-only period is over, monthly payments are made on both the interest and the principal for the remaining term of the loan, and the interest rate is adjusted every year. Interest-only ARMs are available with three-, five-, seven-, and 10-year interest-only terms.
New Construction Loan
If you are working with a builder in a sub-division or development you may be able to obtain a standard mortgage loan. But if you're hiring contractors, electricians, plumbers, and painters, you will probably need a construction loan, which provides funds to pay subcontractors as work progresses.Jumbo Loans
A loan for an amount of money larger than the conforming loan limit set by the government-backed agencies Fannie Mae and Freddie Mac is called a jumbo loan. The agencies buy groups of mortgages and re-sell them as investments. The conforming loan limit is the maximum loan amount that these agencies will buy.Federal Housing Administration (FHA) Mortgages
A mortgage secured by the Federal Housing Administration (FHA) requires a down payment as low as 3.5% of the purchase price.- FHA loans are designed to make purchasing a home more affordable than it would be with a conventional loan, especially for the first-time homebuyer.
- FHA loans are subject to limits on the amount of money that can be borrowed. These limits vary from state to state.
- Low down payment-as little as 3.5%
- Ratios that make it easier for you to qualify
- You can use gifts and cash on hand for closing costs
- May be more affordable than a conventional loan
A mortgage guaranteed by the Department of Veteran Affairs (VA) requires little or no down payment.
- VA loans are available only to military personnel, veterans, or the spouses of veterans who died of service-related injuries. VA loans are designed to make purchasing a home more affordable than it would be with a conventional loan.
- Under the law, veterans are entitled to VA home loan benefits based on military service. Eligible veterans must still meet credit and income standards in order to qualify for a VA-guaranteed loan.
