One of the first questions you are bound to ask yourself when you want to buy a home is, “which mortgage is right for me?”
Basically, purchase and refinance loans are divided into fixed-rate or adjustable-rate mortgages. Once you decide on fixed or adjustable, you will also need to consider the loan term.
Here is a brief guide to the different mortgage types available in today’s market.
Long-term fixed-rate mortgages are the staple of the American mortgage market. With a fixed rate and a fixed monthly payment, these loans provide the most stable and predictable cost of homeownership.
This makes fixed-rate mortgages very popular for homebuyers (and refinancers), especially at times when interest rates are low.
The most common term for a fixed-rate mortgage is 30 years, but shorter-terms of 20, 15 and even 10 years are also available. A shorter term means a higher monthly payment but much lower overall interest costs. Since a higher monthly payment limits the amount of mortgage a given income can support, most homebuyers decide to spread their monthly payments out over a 30-year term.
Some mortgage lenders will allow you to customize your mortgage term to be whatever length you want it to be by adjusting the monthly payments. You can also customize your loan term yourself with regular prepayments.
Adjustable-rate mortgage (ARM)
Since monthly payments can both rise and fall, ARMs carry risks that fixed-rate loans do not. ARMs are useful for some borrowers -- even first time borrowers -- but do require some additional understanding and diligence on the part of the consumer. There are knowable risks, and some can be managed with a little planning. To get a better understanding of adjustable-rate mortgages and how they work, read HSH.com’s guide to adjustable-rate mortgages.
Traditional ARMs trade long-term stability for regular changes in your interest rate and monthly payment. This can work to your advantage or disadvantage.
Traditional ARMs have interest rates that adjust every year, every three years or every five years. You may hear these referred to as "1/1,” "3/3” or "5/5" ARMs. These refer to how frequently the rate changes and how long the new rate remains. For example, initial interest rate in a 5/5 ARM is fixed for the first five years. After that, the interest rate resets to a new rate every five years until the loan reaches the end of its 30-year term.
Traditional ARMs are usually offered at a lower initial rate than fixed-rate mortgages, and usually have repayment terms of 30 years. Depending upon where interest rates are, high or low, these products may offer you a chance to get a lower rate today, enjoy that for a few years and then get an even lower rate in the future. Of course, the reverse is true, and you could end up with a higher rate, making your mortgage less affordable in the future.
Note: Not all lenders offer these products. Traditional ARMs are more favorable to homebuyers when interest rates are fairly high, since they offer the chance at lower rates in the future.
Almost a "best of both worlds" product, Hybrid ARMs offer initial fixed interest rate periods of three, five, seven or 10 years; after that, they most frequently turn into a 1-year ARM, where the interest rate will change every year thereafter.
Like traditional ARMs, these are usually available at lower rates than fixed-rate mortgages and have total repayment terms of 30 years. Because they have a variety of fixed-rate periods, Hybrid ARMs offer borrowers a lower initial interest rate and a fixed-rate mortgage that fits their expected time frame.
That said, these products carry risks since a low fixed rate (for a few years) could come to an end in the middle of a higher-rate climate, and monthly payments can jump. Because of this, Hybrid ARMs are best for borrowers who are very certain about how long they plan on remaining in the home, or those who have the wherewithal to manage any payment increase in the future.
Although often discussed as though it is one, FHA isn't a mortgage. It stands for the Federal Housing Administration, a government entity which essentially runs an insurance pool supported by fees that FHA mortgage borrowers pay. This insurance pool virtually eliminates the risk of loss to a lender, so FHA-backed loans can be offered to riskier borrowers, especially those with lower credit scores and smaller down payments.
FHA backs both fixed- and adjustable-rate mortgage products. Popular among first-time homebuyers, the 30-year fixed-rate FHA-backed loan is available at rates even lower than more traditional "conforming" mortgages, even in cases where borrowers have weak credit.
While down payment requirements of as little as 3.5 percent make them especially attractive, borrowers must pay an upfront and annual premium to fund the insurance pool noted above. These may also compete with other low downpayment mortgages in the market, such as HomeReady and HomePossible options.
To learn more about FHA mortgages, read “Advantages of FHA mortgages in 2018.”
VA home loans are mortgages guaranteed by the U.S. Department of Veterans Affairs (VA). These loans, issues by private lenders, are offered to eligible servicemembers and their families at lower rates and at more favorable terms.
To determine if you are eligible and to learn more about these mortgages, visit our VA home loans page.
Also not a kind of loan, a "jumbo" mortgage refers specifically to the size of the loan being borrowed. Fannie Mae and Freddie Mac have limits on the size of mortgages they can buy from lenders; in most areas this cap is $453,100 (up to $636,150 in certain "high-cost" markets). Jumbo mortgages come in fixed and adjustable (traditional and hybrid) varieties.
QM and Non-QM mortgages
Under regulations imposed by Dodd-Frank legislation, a definition for a so-called Qualified Mortgage was set. Essentially, a QM is a standard mortgage with no "risky" features such as interest-only payments, balloon payments, 40-year terms and other items. QMs also allow for borrower debt-to-income level of 43% or less, and can be backed by Fannie Mae and Freddie Mac. Presently, Fannie Mae and Freddie Mac are using special "temporary" exemptions from QM rules to buy or back mortgages with DTI ratios as high as 50% in some circumstances.
Non-QM mortgages can include interest-only payments, alternative income and asset documentation, 40-year terms and other features. Non-QM mortgages may be offered by lenders, who usually put them in their "portfolio" of loans they hold. For the most part, they are made only to the best qualify borrowers or those who have strong risk-offsetting financial characteristics, such as a large down payment or very high levels of assets. Currently, most non-QM mortgages are made to jumbo mortgage borrowers.
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