Understanding home mortgage options
When reviewing your home mortgage options, you have a lot of variables to consider. The loan term, type, and interest rate all work together to determine things like your monthly payment and the total cost of your loan.
There isn't a one-size-fits-all mortgage plan, which is why it's important to research your options. Having a clear idea of what you want will help you compare offers from different lenders, so you don't find yourself locked into a mortgage you can’t afford.
It’s also a good idea to start your research early. That gives you time to do things like improve your credit score or save for a larger down payment, which can get you a better loan.
1. Loan types
Lenders also offer different types of mortgage loans. The type you get can affect how much you can borrow and the size down payment required. Depending on your situation, you may only qualify for one type.
Conventional loans. These usually require a 20% down payment, which may limit the price of homes you can afford. On the upside, they usually have lower interest rates than many specialty loan programs.
FHA loans. If you have a lower credit score or can’t swing a 20% down payment, you may qualify for an FHA loan with as little as 3.5% down. As a trade-off, you’ll need mortgage insurance, which increases your monthly payments.
Special programs. Other government loan programs are offered by the Veterans Administration, US Department of Agriculture, and state and local agencies for eligible borrowers.
2. Loan terms
Most mortgages have 30-year terms, which reduce monthly payments to a more comfortable level for most borrowers. However, some mortgages are available to some borrowers with a 15-year term.
In general, a 15-year loan will have a lower interest rate than a 30-year loan. You’ll have higher mortgage payments each month, but you’ll pay less interest over the life of the mortgage.
3. Interest rates
In addition to knowing the terms interest rate you’ll be paying, you need to know the type: fixed rate or adjustable rate mortgage (ARM).
Fixed rate mortgages retain the same interest rate throughout the length of the loan.
Adjustable rate mortgages (ARMs) typically start with a fixed rate period, after which the interest rate can change based on the market. Your lender must give you advance notice of any interest rate change.
Most ARMs are described with 2 numbers, such as 5/1 or 10/3.
- The first number is the length of the fixed rate period.
- The second number is how often the interest rate can change.
For example, a common ARM is 5/1. The first number tells you you’ll have a fixed rate for 5 years. The second number indicates the rate will adjust every year after that.
All other things being equal, an adjustable rate mortgage typically starts with a lower interest rate than a fixed rate mortgage, making it especially attractive at the outset of the loan.
However, borrowers who choose adjustable rate mortgages should be comfortable with some degree of uncertainty about their mortgage payments. If market interest rates increase significantly, so will your monthly payments, once the fixed rate period is over.
Comparing loan estimates
The US government’s Consumer Financial Protection Bureau (CFPB) advises borrowers to always compare official loan estimates before making a final decision. The CFPB website has an interactive example of a Loan Estimate document.
To get a loan estimate, apply for a mortgage. Applying doesn’t mean that either party is committing to sign a loan with each other – it just allows you to get more information about potential mortgage conditions.