You are ready to buy a house – congratulations! Before you start, though, you need to do the hard work of finding a mortgage. If this is your first home, you may not even realize how many mortgage programs are available today. It’s more than choosing the right interest rate or even the right term – you have to put all of the pieces together to choose the right loan.
The Type of Loan
First, you must choose the right type of loan. The choices include:
How do you choose? It comes down to your qualifying factors. Let’s start with conventional loans. Do you have a good credit score? Typically, you need a 660 or higher credit score. Also, will your housing ratio be 28% or less and your total debt ratio 36% or less? If you meet these criteria, you’ll need a 5% down payment too. If you don’t think you can meet these criteria, cross the conventional loan off your list and look at others.
The government-backed loans, such as the FHA, VA, and USDA loans have more flexible guidelines including:
- FHA loans – 580 credit score, 31% housing ratio, 41% total debt ratio, and 3.5% down payment
- VA loans – 620 credit score, 43% total debt ratio, and no down payment
- USDA loans – 640 credit score, 29% housing ratio, 41% total debt ratio, and no down payment
The Loan’s Term
Next, you want to think of the loan’s term. Homes are expensive and if you don’t make a large down payment, you’ll borrow a lot of money. It’s natural to go straight for the 30-year term, but that’s not always required. Look at your options.
The shorter your term, the less interest you will pay over the life of the loan. But, shorter terms also come with higher payments. You have less time to pay the loan off in full, so you’ll pay more principal with every payment.
As you figure out what you can afford, look at your debt ratios. Does the higher payment of a 15-year or 20-year term fit? Are you comfortable with the payment? Don’t forget about the real estate taxes and homeowner’s insurance. You’ll need to pay them monthly. If you’ll owe PMI too, factor that into your calculations.
Type of Interest Rate
You think you have it all figured out and then there’s the interest rate. You have two options:
- Fixed interest rate
- Adjustable interest rate
The fixed interest rate stays the same for the term of the loan. The rate you lock in and close with is the rate you keep until you pay off the loan or refinance it. You can always predict your mortgage payment because it will never change. The only portion of it that may change is the portion you pay for taxes and insurance. The mortgage company doesn’t have any control over how much the taxes or insurance fluctuates.
The adjustable interest rate starts as a fixed rate. It remains fixed for a specified term and then adjusts annually. The initial interest rate is the ‘teaser rate.’ It’s attractive enough to get borrowers to choose the program. After the initial period, which is typically 3 – 7 years, the rate adjusts according to the predetermined index and margins. Buyers that won’t stay in the home long-term often choose this option because they can get a great interest rate at the onset of the loan.
If you aren’t sure, opt for the fixed rate. If you don’t know how long you’ll stay in the loan or you can’t handle not knowing your actual mortgage payment each month, choose the fixed rate. If you can handle a bit of adjustment and can afford the maximum amount the payment will get to (you can ask the lifetime cap), then take the adjustable rate and enjoy the initial savings.
Knowing what you want is one thing. Next, you must shop around. You must find lenders that offer the loan you need. Apply with several lenders – at least three. This way you can compare your options. Don’t just look at the loans and take the lowest interest rate, either. Truly look at what they offer.
What is the interest rate? How much are the closing fees? Will the interest rate change? What is the loan’s term? What does the loan cost over its lifetime? Look at the big picture rather than focusing only on the monthly payment. Then you can choose the loan that’s right for you.