Types of Home Loans
Loan Types
Fixed Rate Home Loans
Certainty can be a comforting thing and for some, certainty is a must when it comes to your home loan. Although you can't count on the weather, you can count on a fixed rate home loan. It will have the same interest rate for the entire life of your loan. You may choose from a variety of repayment terms, with 15, 20 and 30 years being the most common.
Fixed rates are a good choice if:
- You like the new rate and want to keep it for the life of your loan.
- You plan to stay in your house a long time.
- You prefer the security of a fixed principal/interest payment over one that changes periodically.
30 Year Fixed Rate Home Loan
- This provides you with the lowest monthly payment out of the fixed rate loan choices.
- This keeps your home loan payments affordable by extending them over a longer period of time.
- This provides maximum tax-deductible interest (talk to your tax advisor).
20 Year Fixed Rate Home Loan
- This type of loan helps you pay off your home loan more quickly and you build equity faster than with a 30 year home loan.
- This has a lower interest rate when compared to a 30 year loan, but you will pay higher monthly payments.
- This will save you a considerable amount of money on the total interest paid over the life of your loan when compared to a 30 year home loan.
15 Year Fixed Rate Home Loan
- This type of loan has higher payments than a 30 year or 20 year home loan, but a lower overall interest rate.
- This saves you a considerable amount of money on total interest paid over the life of your loan when compared to a 20 year home loan and especially when compared to a 30 year home loan.
- This will build equity in your home faster, meaning that you will be paying down the principal of your home much quicker than with a longer term loan.
Adjustable-Rate Mortgages (ARMs)
What goes up, must come down. That's basically the principal of ARMs. The interest rate you pay is adjusted from time to time to keep it in line with changing market rates. This means that when interest rates go up, your monthly home loan payments may go up. And when interest rates go down, your monthly home loan payments may go down.
Now that might sound frightening if you've ever lived in an era when interest rates shot up dramatically, but ARMs have built-in features that reduce the risk of your rate ever going too high. ARMs are attractive because they offer start rates that are lower than the interest rates of fixed rate home loans. This typically enables you to begin with lower monthly payments and qualify for a larger loan.
Reasons why an ARM might be right for you:
- You are planning to move in a few years and consequently aren't concerned about possible rate increases.
- You are confident your income will rise enough in the coming years to handle any increase in payments.
- You need a lower initial interest rate in order to afford the home you want.
How ARMs work:
A start rate, also known as the initial interest rate, gives you a special low monthly payment for a set amount of time (such as 1 year). After the start rate period is over, your interest rate is based on the performance of a financial index, such as the average interest rate or yield on Treasury bills.
Your loan term dictates how often your payments are adjusted based on the index and how much rates and payments increase at each adjustment. A 6-month ARM adjusts every 6 months. A 1-year ARM adjusts once a year.
At each adjustment, the new rate is computed by adding the margin — a predetermined amount that remains the same for the life of your loan — to your financial index. Example: If the interest rate for the financial index was 5.5% and your margin 2%, then your rate at the time of adjustment would be 7.5%.
Two "caps" may put a limit on the maximum amount your rate can increase. The periodic cap sets the maximum your rate can go up from one adjustment period to the next. The life cap sets the maximum interest rate for the life of the loan. Some ARMs offer a conversion feature that allows you to convert to a fixed rate loan at certain times during your loan.
Fixed Period ARMs
If you're worried by the thought of your payment going up in 6 months or a year, or know exactly when you'll be ready to move to a new home, you might want to look into an ARM that protects you against the possibility of rapid interest rate increases for a set number of years.
A fixed period ARM starts with a lower rate than standard fixed rate loans. Your rate then stays the same for the first 3, 5, 7, or 10 years, depending on the fixed period ARM you choose. At the end of that period, your interest rate adjusts every year like a regular ARM according to a financial index (that's why some lenders call them 3/1, 5/1, 7/1 and 10/1 ARMs).
Fixed period loans may work well for you if:
- You plan to be in a home for a short period of time.
- You expect to gradually increase your income and you want a few years at a set payment level before potentially paying a higher monthly payment for your home loan.
- You intend to refinance before the adjustment period on your ARM loan begins.
Government Loans
The Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA) offer government-insured loans. These loans have features that make them easier for first-time home buyers to obtain. These features include low down payments and flexible lending guidelines. In order to receive an FHA or VA loan, you may apply through an approved lender.
An FHA Loan offers the following features:
- Low down payment (usually 3% of the FHA appraisal value of the desired home or the purchase price of the desired home, whichever is lower)
- No maximum income/earning limitations
- Fixed rate and ARM loans available
- Insurance from the federal government replaces private mortgage insurance
- Maximum loan amounts vary by county
A VA Loan offers the following features:
- A loan requiring no down payment for up to $359,650 for qualified veterans.
- Loans up to $375,000 available for qualified veterans with required down payment
- Fixed rate loans only
- More flexible qualification guidelines than FHA or conventional loans
Loans over $417,000 (Jumbo)
Loans for more than $417,000 are called jumbo or non-conforming loans. They exceed the loan amounts allowed by Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) — two government-sponsored enterprises that help facilitate the availability of home loans by investing throughout the country.
The loan amount that qualifies as a jumbo or non-conforming loan is reset each year. Non-conforming loans typically have higher interest rates and different requirements for your down payment.
