What’s the Best Mortgage Type for You?

When you purchase a home, there are two main ways to pay for the property: You can pay the entire purchase price in cash, or you can pay a portion of the purchase price (the down payment) at closing and borrow the rest.

Only about one in five U.S. homes are purchased in cash, according to the National Association of REALTORS®. The median home price in the U.S. is now $218,000, according to Zillow, so unless you have access to this much liquid cash and are willing to spend it all in a single transaction, you’ll need to take out a mortgage in order to buy a home.

There are several different types of mortgages, so how do you know which is the best mortgage for you? This article explains the different types of home mortgages to help you make the right mortgage decision for you and your family.

Fixed- and Adjustable-Rate Mortgages

The first thing to understand is that all mortgages fall into one of two broad categories: fixed-rate mortgages and adjustable-rate mortgages (or ARMs). As the name implies, the interest rate on a fixed-rate mortgage will remain the same throughout the term of the loan. Fixed-rate mortgage loan terms are usually 15 or 30 years, though some lenders also make mortgages for as few as 8 years and up to 35 years available to borrowers.

With ARMs, after an initial fixed-rate period, the interest rate will fluctuate based on changing market rates. The ARM rate will be based on a benchmark index, such as Monthly Treasury Average (MTA) or the London InterBank Offered Rate (LIBOR), plus a margin. The index fluctuates while the margin remains constant over the term of the mortgage.

There are several different factors you should consider in deciding whether to opt for a fixed-rate mortgage or an ARM. Perhaps the most important is your comfort level with the possibility that interest rates could rise in the future and how that will affect your mortgage payment.

With an ARM, your mortgage payments will go up if interest rates rise after the fixed period. Choosing a fixed-rate mortgage eliminates this risk. Of course, rates could fall in the future, which would lower your mortgage payment. Most experts agree they are likely to continue to rise.

Another factor is how long you plan to live in the home. If you just plan to stay in the home for a few years — for example, no longer than the initial fixed-rate period — an ARM could be a wise choice since the interest rate during this period will be relatively low. First time home buyers typically stay in their home for 7 years. 

Types of Fixed-Rate Mortgages

There are several different types of mortgage loans within the broad category of fixed-rate mortgages, including the following:·     

Conventional mortgage— This is the most common type of home mortgage loan and usually offers the lowest monthly payment. Conventional mortgage terms are usually 15, 20, or 30 years, however, terms for as few as 8 years and as high as 25 years are available.

You’ll need a good credit score to qualify for a conventional mortgage — typically 620 or higher. Down payments on conventional mortgages can be as low as 3%, but if your down payment is less than 20%, you will have to purchase private mortgage insurance (PMI) to protect the lender in case of default.   

Federal Housing Authority (FHA) loan— These mortgages typically have less stringent credit and down payment requirements and permit higher debt-to-income ratios (DTI). For example, you may be able to obtain an FHA loan with just a 3.5% down payment and a credit score of 580. They also feature lower interest rates but generally have higher closing costs and higher monthly payments due to the PMI requirement. Another benefit to FHA loans is that they are more lenient when it comes to the amount of time since a bankruptcy or foreclosure.

There are no income limits with FHA loans, but there are limits on DTI and also on the size of the mortgage — limits on mortgage size vary by county. The FHA loan charges an upfront premium for mortgage insurance of 1.75% and a monthly insurance premium that varies based on the Loan-to-Value ratio (LTV).

Veterans Administration (VA) loan— These mortgages are specially designed for U.S. military veterans, service members, and select military spouses. If you qualify for a VA mortgage, you may be able to purchase a home with no down payment. The minimum credit score you need to qualify for a VA mortgage is 580. They also permit higher DTI and are more lenient on the amount of time since a bankruptcy or foreclosure.

You do not have to purchase PMI with a VA mortgage because the loan is backed by the federal government. Like FHA loans, there are loan limits with VA mortgages, as well as an upfront funding fee that can be rolled into your total loan amount.

U.S. Department of Agriculture (USDA) rural housing loan— These mortgages may also enable you to purchase a home with no down payment. USDA loans are available to low to moderate income individuals and families who live in rural and outlying metropolitan areas (as defined by county and ZIP code).

The minimum credit score you need to qualify for a USDA loan is also 580, and there are no home purchase price limits. Another benefit of USDA loans is that they are more lenient when it comes to the amount of time since a bankruptcy or foreclosure.

Portfolio/Non-Conforming Loans - These loans have higher interest but more lenient requirements.  They may feature bank statement only programs, limited employment verifications, and credit scores as low as 520.

Perform Careful Research and Due Diligence

Taking out a home mortgage is one of the biggest financial commitments you’ll ever make. Therefore, you should take the time to carefully research your options with your lending specialist in order to choose the best mortgage for you.

About the Author: Dr. Steven Kaufman, is an accomplished investor, entrepreneur, and philanthropist. He isthe founder and Chief Acceleration Officer of ZeusLending.com, an online provider of real estate financing products including traditional and non-traditional mortgages, hard money and bridge loans, and real estate crowdfunding investment opportunities.  Steven has been interviewed by local and national news organizations like FOX, ABC, CBS, CNN, and Bloomberg on the financial markets, and he is a contributing author at Entrepreneur.com.