Buying a home, especially for the first time, can be overwhelming. There are many choices to make, from location and budget to size and considerations for the future. You also need to decide how to finance your new home.
Home loans are numerous and varied. Not every loan type is right for every buyer. To make the right choice for financing this big purchase, understand your options. With this information, you can choose a loan based on qualifications, down payment, interest, insurance, and more.
This is the most common type of conventional loan, a loan not guaranteed or insured by the federal government. A conventional loan with a fixed interest rate is known as a fixed-rate loan or mortgage. You’ll receive an interest rate based on the current market and pay that rate for the loan duration, which can be 15-plus years.
A fixed-rate, conventional loan can be difficult to qualify for because of the strict requirements lenders set. You will need a higher credit score and a lower income-to-debt ratio. You’ll also need to come up with a higher down payment than with other loans.
Although they are more challenging to get, fixed-rate loans are desirable for many reasons. If you qualify, you get a set interest rate and know exactly what you have to pay each month. There are no surprises. The overall cost of this mortgage will also be lower than most other options. Choose a fixed-rate loan if you qualify and if you plan to stay in your new home for many years.
If you don’t plan to hold onto your new home for more than a few years, consider an adjustable-rate mortgage (ARM). This is another type of conventional loan, but it comes with a variable interest rate. It starts with a low interest rate for a set period of time, typically one, five, or seven years. After that initial period, the interest rate changes with the market.
An ARM has the benefit of making it easier to buy a first home if you struggle to qualify for a fixed-rate loan. If you have a lower credit score, you likely can’t get a reasonable rate, so going with an ARM saves money for the initial period.
The risk, of course, with an ARM, is that your monthly payments can spike after the initial low-rate period. The fluctuations in payment can be difficult to budget. If you only plan to stay in a new home for a few years, this option is less risky and can save you money.
The Federal Housing Authority (FHA) backs FHA loans, which have many benefits for some first-time buyers. It’s easier to qualify for these loans than for conventional mortgages. You can get approved with a lower credit score.
Another benefit is that FHA loans do not require big down payments. Compared to conventional loans with down payments of up to 20 percent of the purchase price, FHA down payments can be as little as 3.5 percent. If you can’t come up with the money for a big down payment, this is a good option.
A downside to this type of loan is the overall cost. All FHA loans require mortgage insurance, an additional cost to the home buyer. If you have decent credit and can afford 10 to 20 percent for a down payment, a conventional loan may be less expensive in the long run.
If you served in the military, you might qualify for a loan guaranteed by the U.S. Department of Veterans Affairs (VA). To get one, you have to go to the VA for a certificate of eligibility. You can then use the certificate when applying for conventional loans.
The biggest draw for a VA loan is that it does not require any down payment. Use a VA home loan calculator to find out what your monthly payment will be for houses you’re considering. It will help you compare the costs to other loan options.
The U.S. Department of Agriculture (USDA) also offers a government-guaranteed loan with no down payment. Like an FHA loan, a USDA loan requires mortgage insurance premiums, but it is usually a less expensive option because of lower interest rates.
The downside to a USDA loan is that there are qualifying factors. You must be purchasing in an eligible rural community, although some suburbs qualify. Your income must be close to or below the median income for the area. The loan is designed to help medium and low-income buyers in rural areas.
Choose Your Loan Wisely
You have options when it comes to financing a new home. It’s a mistake to assume everyone needs to use a conventional fixed-rate mortgage. Look at your options, weigh the pros and cons, and choose the loan that makes the most sense for your situation and finances.