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Mortgage Shopping 101

Mortgage Shopping 101
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Loan Types You Need To Know

When it comes to building your new home, one of the key steps is to secure a mortgage that is right for you. This means you will likely have to do some research and shopping around to learn what the options are and where you can get the best rate and terms. Doing your homework can save you a lot of money in the end.

It’s important to understand the different types of mortgages available and how they work. Not all mortgages are the same. Some loans are better depending on how long you plan to live in your home and your current financial situation.

Let’s explore the main options in greater detail.

Fixed-rate Loan

When people think of mortgages, they usually first explore fixed-rate loans. With this type of mortgage, the interest rate you get when you sign your mortgage papers is the one that you pay for the life of the loan period. Most fixed-rate mortgages last between 15 and 30 years, so if you agreed to an interest rate of 3.8 percent on a 15-year mortgage, you’ll pay 3.8 percent for 15 years.

Is this mortgage right you? If you’re someone who doesn’t like to risk interest rates increasing, and you plan to be in your home for a long time, this is a good option to consider. Fixed-rate mortgages remove the worry of interest rates that can change quickly. You will also be able to budget for your payment for years to come.

Adjustable-rate Mortgages

An adjustable-rate mortgage (ARM) gives you a fixed interest rate for a shorter period of time, after which the interest will be adjusted. So if your first mortgage term is 10 years, you will pay your initial interest rate of 3.8 percent for that period of time. However, after that period, your mortgage will adjust annually based on the current interest rates – it may increase or it may decrease. The good news is that your initial interest rate will likely be a lower interest rate than the fixed-rate mortgage offers.

Is this mortgage right you? If your credit score is low, you could get a better interest rate with an ARM compared to a fixed-rate loan. This could make it more affordable for you in the short run. However, when the adjustment period is over, you may have a bigger monthly payment if interest rates jump in five to 10 years (depending on the terms of your loan). Ask questions up front about how often the interest rate will be adjusted. Be sure to find out the worst-case scenario for which you should plan. In some cases, refinancing in the future is not an option, which means you’d be stuck with a higher monthly payment. If you’re planning to stay in your home for a long time, you need to consider if you can afford a larger payment in the future. If you’re not planning to be in your home after the adjustment period is over, this might be a good route to go.

FHA Loans

A Federal Housing Administration (FHA) loan is generally a fixed-rate loan over 15 or 30 years, but it requires a much smaller down payment. To secure an FHA mortgage, you may only have to invest 3.5 percent of the value of your home to get started. When you compare this to conventional mortgages that require a 20 percent down payment, you can see that an FHA loan requires a much smaller up front investment. However, you may also be required to pay additional fees at the start of an FHA loan. One fee may be a mortgage insurance premium (MIP), which is about 1 percent of the loan. If you have less than 10 percent for a down payment, you will more than likely have to pay an annual mortgage insurance premium. This will be added on to your monthly payment for the length of your loan. One other factor to consider is the size of your mortgage. FHA loans can be no larger than $417,000 total, so if your new home costs more than that, this option will not be a good one for you.

Is this mortgage right you? If you do not have a lot of money for a down payment, this is a good route to go. However, if you can afford the down payment of at least 20 percent, a conventional loan would save you a lot of money on interest and fees in the long run. Additionally, only choose this option if your home’s purchase price is less than $417,000.

VA Loans

A Veterans Affairs (VA) loan is a good option for anyone who has served in the U.S. military. Individuals who qualify for a VA loan can get into a home without a down payment or mortgage insurance requirements. To qualify for this type of mortgage, you must meet some stringent requirements. For instance, you must be purchasing your primary home (not a home that you will use as a rental). Additionally, you cannot purchase a home that requires a lot of work (a fixer-upper) since VA loans are only good for homes that meet “minimum property requirements.”

Is this mortgage right you? If you are a veteran who served 90 days consecutively during wartime, 180 during peacetime, or six years in the reserves, this might be your best choice. Do your research to see if you are qualified to apply.

USDA Loans

This is a program designed for financially-struggling families in rural areas. It’s a great program for people who might not otherwise be able to become homeowners. Since this is a 100 percent government-financed loan, it offers many benefits. You don’t need a down payment, and these loans often come with below market interest rates, too. However, you will have to meet certain financial requirements in order to be eligible.

Is this mortgage right for you? If you live in a rural area, a USDA Rural Development loan can save you money. If your debt load (what you owe to other creditors) is not more than 41 percent of your income and you purchase mortgage insurance, you might be eligible.

Bridge Loan

If you’re already a homeowner and are ready to purchase a new home but haven’t yet sold your current home, you may need a bridge loan. A bridge loan, or gap loan as it is also known, gives you the option to take out a short-term loan until the sale of your first home is finalized. Here’s how it works: your current mortgage and your new mortgage are rolled into one payment. After you sell your current home, the portion of your mortgage that covers your old home will be paid off. After that, you can refinance the balance of your mortgage to cover your new home. You must meet certain credit score requirements in order to be eligible for this option.

Is this mortgage right for you? If your credit score is excellent and your debt-to-income ratio is low, you may qualify if you’re trying to transition between two mortgages. The amount you need to finance cannot be more than 80 percent of the two homes’ combined value. This is a good option for people who are trying to unload a current home and can’t finance two separate mortgages.

Remember—there are many types of loans out there, and this article only covers a few of the major types. You need to decide which best fits your needs by visiting a mortgage specialist. With a little homework, you can get into your new home without breaking your bank.

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