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One of the most common queries–and possibly the most important financial aspect—for first-time homebuyers is choosing a mortgage. In Chapter 3, we told you about how a mortgage can help finance your home and introduced you to a few different ways to figure out your mortgage options. Now, though, we’re giving you the lowdown on the most popular types of loans–and how to decide which is best for you.
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A Breakdown of Mortgage Lingo
There are more than enough varieties of loans for you to find the best option — but first you have to know what the most common types are.
- Fixed-rate mortgage: This home loan maintains the same interest rate for the loan’s entire lifespan, and can usually be taken out for a period of 10, 15, 20, or 30 years. Fixed-rate mortgages are best when interest rates are low.
- Adjustable-rate mortgage (ARM): An ARM has an interest rate that fluctuates based on market conditions, meaning that your monthly payment changes over time. Typically your payments will adjust upward over the life of the loan.
- Hybrid loan: A loan that starts out as a fixed-rate loan for a set period of time (say five, seven, or ten years) and then transitions to a continually adjusting rate. One of the most common versions is the 5/1 ARM loan, which has a fixed rate for five years and then becomes an ARM.
- Federal Housing Administration (FHA) mortgage: A government loan that is issued by lenders in the private sector and insured by the FHA. If a borrower defaults on the loan, the FHA reimburses the lender. This type of loan typically has preset spending limits, but has a low down payment.
- VA loan: Another type of government-issued mortgage which guarantees loans for active military service members, eligible veterans, and surviving family members. It offers competitive rates and a low or nonexistent down payment, although loan sizes are often limited.
- Balloon mortgage: This is usually a fixed-rate mortgage that offers low payments for a set amount of time, after which the entire balance is due. For example, with a $200,000 five-year interest-only balloon loan, you would pay just the interest for five years and then pay back the entire $200,000 at the end of that five-year period.
Movoto’s Buyer Tip:Never give in to a pushy lender who is trying to sell you something you don’t feel comfortable with, particularly a mortgage you don’t think you can afford. |
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Selecting a Loan’s Life
In addition to picking out a type of loan, you also need to decide how long you want the life of the mortgage to be. There are a variety of different lengths available, but two of the most common are 15- and 30-year mortgages.
The primary difference between a 30-year loan and its 15-year counterpart is the size of the monthly payments. A 30-year mortgage has lower monthly payments since you have more time to repay it, meaning that you will have more of your income to spend on other things or save up for other financial goals (think college and retirement).
A 15-year loan could be a good option if you can afford the higher monthly payments and already have a sizeable savings amount for retirement. If by chance you find it difficult to save money, that’s another reason to opt for the 15-year mortgage and more tightly manage your savings.
Keep in mind:
With a 30-year loan, you still have the option to pay it off faster as long as it doesn’t have a prepayment penalty clause. Conversely, the 15-year option could pose a higher risk if you end up having issues with your finances and can’t afford to meet the monthly payments.
With a 30-year loan, you still have the option to pay it off faster as long as it doesn’t have a prepayment penalty clause. Conversely, the 15-year option could pose a higher risk if you end up having issues with your finances and can’t afford to meet the monthly payments.
Other Mortgage Terms to Know
While you’re in the process of selecting your mortgages, odds are good that you will encounter an unfamiliar term (or two). Here are definitions for some of the most common mortgage terms to help you follow the complicated labyrinth that is mortgage shopping.
Locking in: To lock in an interest rate means to agree to the current rate available. By locking in a specific interest rate for a mortgage application, you are agreeing that the interest you will pay on your loan is the rate for that day you lock it in. You want to lock in your mortgage rate if interest rates are low and you think they will start to increase (so you would be taking advantage of the low rate).
Float the Rate: The floating option is the opposite of locking in a loan rate. This means that you opt to continue waiting for changes in the interest rate in the hope that rates will drop–when you would then lock in the rate. Yet if rates go up instead of drop as you’d hoped, you’ll end up paying a higher price.
Points: A point is equivalent to a single percentage of a loan. For example, with a $100,000 loan 3 points would be 3 percent of the loan, or $3,000. You can pay for points at closing to lower your interest rate for the loan, although the points must be paid in cash.
Caps: Caps limit the maximum amount that an interest rate can rise, typically for an adjustable rate. The cap prevents the interest rate from steadily growing over the entire life of the loan.
Steps: Steps limit how much an interest rate can rise or fall within an adjustment period (for an adjustable interest rate). A step correlates to the interest rate percent, so a 1.5 step means that the rate can only vary by 1.5 percent for that adjustment period.
Truth-in-Lending statement: This is a disclosure of the annual percentage rate (APR) of your loan, which a lender is required to notify you of within three days of receiving your application. The statement will also disclose information about the finance charge, payment schedule, late payment charges, and details of additional charges that could arise if you pay off your loan balance before it’s due.
Annual Percentage Rate (APR): This amount represents what the loan will cost you if you keep it for its entire term. The APR includes the interest rate, points, fees, and other costs the lender might charge for his or her company’s business.
Good Faith Estimate: An estimate of all your closing costs based on the lender’s knowledge of any anticipated closing fees, which can appear as a dollar amount or a range. When you submit your mortgage application, the lender is required to give you a Good Faith Estimate.
Tips to Help You Choose
Now that you understand some of the words that will keep popping up in your loan documents, it’s time to narrow down the selection. A few bits of advice for when you’re deciding on a mortgage:
- For a low-down-payment loan, you should consider an FHA loan (which most lenders are able to do)
- Examine your monthly income–if you’re making a lower amount today but expect to have a higher-paying job once you’ve bought the house, this could be a sign that a higher interest rate but lower down payment is right for you
- Estimate how long you plan to stay–If you’re only planning to live in the home for five years or so, you may want to get an adjustable-rate mortgage (ARM)
- If you’re willing to pay points up front, you’ll end up with a loan that has lower interest
- If you believe interest rates will stay low, an (ARM) might be your best option
- If you’d prefer to pay a set monthly amount, a fixed-rate mortgage is probably the right type of loan for you
Movoto’s Buyer Tip: Make an Educated Decision |
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When to Get an ARM
Because this adjustable-rate mortgage depends on the economy, it’s going to be lower when the economy is trending downward. This means that you want to get an ARM when interest rates are falling.
Picking an ARM as rates fall will ensure that your interest rate and your payments similarly drop.
On the other hand, choose a fixed-rate mortgage if interest rates seem to be rising steadily. This will allow you to snag a low rate and lower payments as rates continue to increase.
How to Get the Best Loan
The “best” loan will differ for every individual, based on his or her financial situation. First, you should determine whether you would prefer to pay more up front for a lower rate, or pay nothing initially and have a higher long-term rate.
Once you decide what type of loan is a better option for your budget, there are a few ways to get your desired mortgage at the best rate possible:
- Stay on top of interest rates: These change regularly (sometimes as often as once a day or more), so you should watch rates and lock one in when numbers are falling.
- Watch points and fees: Like interest rates, points and fees also fluctuate on a regular basis–which means you want to apply for a loan when both numbers are on the lower end.
- Consider a broker: A broker’s job is to shop around for you and help you find a good deal on a mortgage. Don’t just accept the first deals they show you, though. Tell them about other deals you’ve found, and be aware that they’re probably trying to make money by selling you a higher loan.
- Negotiate: Request explanations of fees you don’t know about, and compare the rates between different lenders. This way you’ll be able to tell what fees are unnecessarily high and can return armed to bargain for a better deal.
- Check with your lawyer: A lawyer who is familiar with the buying process can help point you in the right direction and offer feedback about rates, since he or she should know the going rate.
What to Do If You’re Rejected
As frustrating as it is to be rejected after all the work you put into finding and applying for the loan, don’t be discouraged. Know that you aren’t the only one–hundreds of individuals get rejected for a loan every day–and that there are ways to try to correct your issues.
Here are suggestions for how to correct some of the more common reasons:
| 1. | Credit report issues: Often a credit report can contain errors that cause lenders to believe you’re higher-risk. If you feel that some information is wrong, try to find physical proof of the mistake and reach out to the company that claims you owe money.
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Inconsistencies: Often lenders will find differences between what you’ve told them and information they discover during their background search. For example, if you tell the lender your salary is $50,000 and he or she calls your employer and learns it’s actually $43,000, you’ll get rejected immediately. When you’re caught in a lie, the lender figures you likely lied about other things on the application and doesn’t consider you a good candidate. The best way to correct this problem? Reapply and be honest on your application.
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Employment Problems: If you’ve had a job for fewer than two years, are self-employed, or just recently lost your job, chances are your application won’t be approved. There are no quick fixes to most of these issues–your best bet is to try again after a few years have passed and you have a stable job.
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Specifically, if you are or were:
- Employed less than two years: Wait a few years and try reapplying once your records show a consistent position and a stable income. However, if you’re working for a company and its partner company offers you the same position for a higher income, this is a case where lenders want you to take the job and earn the extra money.
- Self-employed: You should be self-employed for at least two years to show stability. Also look at your net income (the gross income minus all of your expenses) as a basis for your mortgage, because that’s how your lender will see it–even if you think you can spend more.
- Recently unemployed: If you lose your job during the home buying process, your application will likely be rejected. If your spouse doesn’t make enough to support mortgage payments, all you can do is wait to reapply once you’ve gotten a new job and have held the position for a few years.
