Purchasing a home can be overwhelming, especially when it comes to financing. If you are feeling a little in over your head, there’s no need to panic. Once you get a clear understanding of what your financing options are and which home loan is right for you, you can go back to focusing on what matters most, finding your dream home. Assuming you’ve done some homework, you’ve probably already figured out there are more than four kinds of home loans to consider. Nonetheless, these particular home loans are the most common and tend to be the best option for the majority of homeowners. So, to be better assist you and your needs, here are the pros and cons of conventional, fixed-rate, adjustable-rate, and government-insured mortgages/home loans.
A conventional mortgage is uninsured by the government that typically requires a PMI (conforming and non-conforming loans). A Conforming loan does not exceed the amount set by Fannie Mae or Freddie Mac. Whereas, non-conforming loans simply do not meet those guidelines. The pros of a conventional mortgage include flexible use (for investment or primary and secondary homes), cancellation of PMI after gaining 20 percent equity, overall lower borrowing costs, and when backed by Fannie or Freddie allow for less down (less than 4 percent). The downside with conventional mortgages, however, is a required FICO of 620 or better, a 45 to 50 percent debt-to-income ratio, and quite a bit of documentation. Nonetheless, if you have decent credit and a stable income, you should definitely consider a conventional mortgage.
Another home loan to consider is a fixed-rate mortgage. Just as it’s implied, a fixed-rate mortgage keeps the same interest rate for the life of the loan. Often, you’ll find 15-,20-,30-year fixed-rate loans. Here, the pros are pretty straight forward—your monthly payments don’t fluctuate, which means your housing/mortgage budget doesn’t either. However, with a fixed-rate, you tend to pay more in interest, and the interest rates are higher than most. Furthermore, building home equity will take some time. As a result, this particular home loan would be best for someone who’s found their forever home, i.e., you plan to keep your home for seven-plus years. A fixed-rate mortgage works best in this scenario because it allows for more financial stability.
Alternatively, an adjustable-rate mortgage’s interest rates fluctuate based on the market condition. The biggest plus here is you can find ARMs with fixed interest for say five years. Likewise, ARMs with interest caps are also available (typically monthly caps). Thus, an ARM is ideal or people looking to sell after a few years; this will help you save on interest payments. Of course, ARMs come with a certain amount of risk as home values are always in flux, making it harder to sell or refinance before your loan terms change. Moreover, many people default on ARMs when payments become too hard to manage. Ultimately, ARMs are a risky venture, but if you play your cards right, the savings could be significant.
Government-insured mortgages are essentially homeownership assistance programs (FHA, VA, and USDA). Here, FHA loans are available to individuals with a FICO score of 580+, a minimal down payment, and non-pristine credit. FHA loans do, however, require two PMIs—one upfront and annually if you put less than ten percent down (no cancellation available). Conversely, VA loans are for active-duty military persons and veterans. These loans do not require a PMI or down payment, and closing cost is either capped or seller paid. However, VA loans do include a funding fee. Lastly, there USDA loans for low-income homebuyers in rural areas. Overall, these government-insured loans are for people who don’t qualify for other loan types or who are selected to benefit from these programs.