Knowing the pros and cons of home loans can alleviate the overwhelm financing can cause.
Buying a home is an exciting endeavor! The financing, however, can be a little overwhelming. But knowing the “in’s and out’s” of home loans can help subdue or even eliminate the overwhelm financing brings. So do your homework. Find out about the five types of home loans, and the different upfront and long-term costs of each. Then you’ll be able to confidently choose which loan will work best for you.
5 Types of Home Loans and Their Pros and Cons
- Conventional loans
- Jumbo loans
- Government-insured loans
- Fixed-rate loans
- Adjustable-rate loans
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Conventional Loans
There are two types of conventional loans: conforming and non-conforming. Neither are insured by the federal government. Conforming means the loan amount falls within maximum limits set by Fannie Mae or Freddie Mac. Non-conforming means the loan amount doesn’t fall within the maximum limits set by these government agencies.
When you put down less than 20 percent of the sales price on a conventional loan, lenders require you to pay private mortgage insurance (PMI).
If you have strong credit, a stable income and employment history, and a down payment of at least three percent, a conventional loan is ideal for you.
Pros
- Can be used for a primary home, second home, or investment property
- Overall borrowing costs tend to be lower than other types of mortgages, even if interest rates are slightly higher
- Can ask your lender to cancel PMI once you’ve gained 20 percent equity
- Can pay as little as three percent down for loans backed by Fannie Mae or Freddie Mac
Cons
- Minimum FICO score of 620 or higher is required
- Must have a debt-to-income ratio of 45 to 50 percent.
- Must pay PMI if your down payment is less than 20 percent of the home’s purchase price.
- Documentation is required to verify income, assets, down payment, and employment.
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Jumbo Loans
Jumbo mortgages are conventional home loans with non-conforming loan limits. This means the home price exceeds federal loan limits. For 2018, the maximum conforming loan limit for single-family homes in most of the U.S. is $453,100, according to the Federal Housing Finance Agency. In certain high-cost areas, the price ceiling is $679,650. Jumbo loans are more common in higher-cost areas and generally, require more in-depth documentation to qualify for one.
If you are an affluent buyer purchasing a high-end home, a jumbo home loan makes sense for you. To qualify for a jumbo loan, you should have good-to-excellent credit, a high income, and a substantial down payment (well above 30 percent). Many reputable lenders offer jumbo loans at competitive rates.
Pros
- You can borrow more money to buy a home in a pricier area
- Interest rates tend to be competitive with other conventional home loans
Cons
- Down payment of at least ten to 20 percent is required
- A FICO score of 700 or higher is required, although some lenders will accept a minimum score of 660
- Debt-to-income ratio cannot be above 45 percent.
- Must show you have assets that equal ten percent of the loan amount in cash or savings accounts
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Government-Insured Loans
Although the U.S. government isn’t a mortgage lender, it does help Americans become homeowners. Three government agencies back loans: The Federal Housing Administration (FHA), the U.S. Department of Agriculture (USDA), and the U.S. Department of Veterans Affairs (VA) are three government agencies that back loans.
FHA loans are popular among mortgage borrowers. They help make homeownership possible for those with small down payments and less than pristine credit. A minimum FICO score of 580 is required to get the FHA’s maximum 3.5 percent financing. However, a credit score of 500 is acceptable with at least 10 percent down. If a homeowner puts less than ten percent down, the FHA requires two mortgage insurance premiums. One mortgage insurance premium is paid upfront and the other is paid annually for the life of the loan. Note: This can increase the overall cost of a mortgage.
VA loans provide flexible, low-interest mortgages for active duty and veterans U.S. military members and their families. They do not require a down payment or PMI. Closing costs are generally capped and may be paid by the seller. To help offset the VA loan program’s cost to taxpayers, a percentage of the loan amount, known as a funding fee, is charged on VA loans. This fee, as well as other closing costs, can be rolled into most VA loans or paid upfront at closing.
USDA loans help moderate- to low-income borrowers buy homes in rural areas. To qualify for a USDA loan, you must purchase a home in a USDA-eligible area and meet certain income limits. There are even some USDA loans that do not require a down payment for eligible borrowers with low incomes.
If you have low cash savings, less-than-pristine credit, and cannot qualify for a conventional loan, a government-insured loan is ideal. Compared to other types of loans for military borrowers, VA loans tend to offer the best terms and most flexibility.
Pros
- Help you finance a home when you don’t qualify for a conventional loan
- Credit requirements are more relaxed
- A large down payment is not required
- Available to repeat and first-time buyers
Cons
- Expect to pay mandatory mortgage insurance premiums that cannot be canceled on some loans
- Higher overall borrowing costs
- More documentation is required, depending on the loan type, to prove eligibility
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Fixed-Rate Loans
Fixed-rate loans keep the same interest rate over the life of your loan. This means your monthly mortgage payments always stay the same, and that’s a great thing! Fixed loans typically come in terms of 15, 20 or 30 years.
If you plan to stay in your home for seven to ten years, the stability with monthly payments make a fixed-rate mortgage ideal for you.
Pros
- Monthly principal and interest payments stay the same throughout the life of the loan
- Precisely budget other expenses month-to-month
Cons
- Pay more interest with a longer-term, fixed-rate loan
- Takes longer to build equity in your home
- Interest rates typically are higher than rates on adjustable-rate mortgages
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Adjustable-Rate Mortgages
Adjustable-rate mortgages (ARMs) lack the stability of fixed-rate loans. Their interest rates go up or down with market conditions. ARMs may start out with a fixed interest rate, but after a few years will reset to a variable interest rate for the remainder of the term. If you are considering an ARM, look for one that caps how much your interest rate or monthly mortgage rate can increase. This will help you avoid financial trouble when the loan resets.
There is a certain level of risk associated with an ARM. You must be comfortable with that risk before obtaining one. An ARM may be ideal if you don’t plan to stay in your home for many years, saving you a lot in interest payments.
Pros
- Lower fixed rate in the first few years of homeownership
- Substantial amount of money on interest payments saved
Cons
- Monthly mortgage payments could become unaffordable, resulting in defaulting on the loan
- Home values may fall in a few years, making it harder to refinance or sell your home before the loan resets
It Pays to Know the Pros and Cons
From the very beginning of your house hunting efforts to closing day, then on to the day you sell your home or pay off your mortgage, it pays to know the pros and cons of home loans. The type of home loan you choose to obtain will make a big difference in costs upfront and long-term.
With over 30 years of experience in the Brooklyn real estate market, Charles D’Alessandro is a Brooklyn Real Estate Agent you can trust. He’ll help you understand the differences and benefits of home loans so you can choose one that’s best for you. Ready to enter the real estate market in search of the perfect home? Contact Charles D’Alessandro, your Brooklyn Real Estate Agent with Fillmore Real Estate at (718) 253-9600 ext.206 or email [email protected] today.
Resource: 5 Types of Mortgage Loans for Homebuyers at Bankrate.com
Charles D’Alessandro
Your Brooklyn Real Estate Agent
718-253-9600 ext. 206
[email protected]
