Purchasing a home is a big decision. After all, it's one of the biggest purchases you'll ever make in your lifetime.
Unless you're lucky enough to be able to save up enough money to purchase a home with cash (the average home listing price in the U.S. is $289,000, according to Zillow), you'll need to take out a mortgage to purchase your home.
When shopping for a mortgage, you'll find that you have many options. It's important to understand these options to ensure that you choose the right mortgage for you.
Fixed vs. Adjustable-Rate Mortgages
One of the first things you'll need to decide is whether you want a fixed-rate or adjustable-rate mortgage.
Fixed-Rate Mortgages
Just as the name suggests, fixed-rate mortgages have a fixed interest rate. In other words, the rate stays the same for the entirety of the loan.
A fixed-rate mortgage means that your monthly payment will remain the same - no matter what - during the lifetime of the loan.
Adjustable-Rate Mortgages (ARMs)
ARMs, on the other hand, have variable interest rates. ARMs may have a lower interest rate for the first few years, but payments will almost inevitably increase over time as interest rates increase.
ARMs are a poor choice for mortgages, and it becomes incredibly difficult to budget for your monthly payment simply because it's constantly fluctuating.
Types of Mortgages
There are several types of mortgage loans, including:
Conventional
Conventional loans are distributed by banks or other financial institutions, and they are not backed by the government. This means that lenders can charge a higher interest rate and require a higher down payment.
If your down payment is less than 20%, you will be required to pay private mortgage insurance (PMI).
Still, when you calculate all of the interest and fees, conventional loans are usually less expensive than unconventional loans.
FHA Loan
A Federal Housing Administration (FHA) loan allows buyers to purchase a home with as little as 3.5% down.
With this type of loan, you will be required to pay a mortgage insurance premium (MIP), which is a fee that's similar to PMI. MIP will have to be paid over the lifetime of the loan, unless you pay more than 10% as a down payment. Even in this case, you'll still be paying the fee for 11 years.
VA Loan
Military veterans can acquire a mortgage through the Department of Veterans Affairs (VA) with virtually no down payment or mortgage insurance.
VA loans do come with a funding fee which can range anywhere from 1.25% to 3.3% of the loan.
USDA Loan
If you live in a rural area, you may be able to qualify for a USDA loan which requires no down payment and offers competitive interest rates.
The primary drawback with a USDA loan is that you cannot refinance to get a better rate. The prepayment penalties are also unfavorable.
It's important to weigh all of your options carefully before choosing a mortgage. While conventional loans often have a lower overall cost, unconventional loans have more favorable down payment costs, particularly if this is your first time buying a home.
