Homebuyers' Walkthrough: Which Type Of Mortgage Is Best?
Most homebuyers will need to secure a mortgage to finance their home. The lending climate has changed following the late 2000s financial crisis, and it may be more difficult to get approved for a mortgage. Many lenders are now requiring higher credit scores and higher down payments.
A mortgage, in simple terms, is a loan that is used to purchase a house. Homebuyers will have to choose from a variety of mortgages that are available in the marketplace.
A fixed-rate mortgage (sometimes called a "plain vanilla" mortgage) is one that has a set (or fixed) rate of interest for the entire loan term. It is the traditional loan used to finance a home purchase, and the type that most people think of when thinking about mortgages.
Fixed-rate mortgages allow buyers to spread out the costs of purchasing a home over time, while making predictable payments each month. The term of the loan varies, though 15-year and 30-year fixed-rate mortgages are the most common. Borrowers can normally make extra payments in order to shorten the loan term without incurring any prepayment penalties.
Shorter-term fixed-rate mortgages will incur less interest costs over the life of the loan, but will have higher monthly payments. Conversely, longer-term loans will have higher overall interest costs with smaller monthly payments.
A disadvantage with fixed-rate mortgages is that the interest rate on the loan does not change, even if interest rates fall significantly. It may be financially beneficial to some borrowers to refinance the loan if interest rates drop.
Fixed-rate loans are ideal for buyers who have a steady source of predictable income and intend to own their homes for an extended period of time.
Variable-rate mortgages are also called adjustable-rate or floating-rate mortgages. The interest rate charged for this type of loan changes periodically to reflect current interest rates, and generally rises over time. The introductory loan interest rate - commonly called a teaser rate - is often lower than the rate available on a fixed-rate mortgage. As a result, variable-rate mortgages can make it easier to qualify for a larger loan because of the lower initial monthly payments.
A disadvantage to variable-rate mortgages is the payment shock that can happen when the interest rate increases. These sudden and sometimes sizable increases in the monthly mortgage payment can cause financial hardships for unprepared borrowers. Realizing that rates may rise at any time following the introductory period and planning ahead for any increases can help borrowers to stay in control of their mortgages.
Variable-rate mortgages are typically the recommended option for borrowers who anticipate declining interest rates (to avoid being locked in to a higher interest rate with a fixed-rate mortgage), who plan on living in the home for a limited number of years, or who expect to be able to pay off the mortgage before the interest rate adjustment period is reached.
Many first-time homebuyers can qualify for a Federal Housing Authority (FHA)-backed mortgage, which typically has less rigid borrower requirements:
- Low minimum down payment (about 3.5%)
- Reasonable credit expectations
- More flexible income requirements
- The statutory limit for the geographic area where the home is located
- The maximum loan-to-value (LTV) ratio
A short-term loan used to finance the building of a home or another ...
The projected total cost that a reverse mortgage holder should ...
definition of a commercial real estate loan
A National Association of Realtors member benefit providing realtors ...
The Housing Choice Voucher Program helps families with very low ...
A temporary postponement of mortgage payments.
Read about collateralized mortgage obligations and their relationship with small investors, plus what risks small investors ...
Learn about the difference between the Z-spread and option-adjusted spread valuations of future cash flows for bonds, and ...
Find out how debt securitization started, how it works and why the government facilitated the mortgage-backed security market ...
Learn more about the loan-to-value ratio, what the ratio measures and how to calculate the loan-to-value ratio on Microsoft ...