There are 3 common loan options: fixed rate, adjustable rate, and federally-backed loans, each with their own pros and cons.
One quick but important concept to understand before we dive in is mortgage insurance (frequently referred to as PMI). No matter which of these home loans you choose, unless you put 20% down, you’ll likely end up having to pay a monthly mortgage insurance on top of principle and interest. In layman’s terms, it’s essentially insurance that you won’t default on your loan. However, if you’re only able to put the minimum down on a home, I would certainly take having to pay mortgage insurance over not being able to buy a home. You can always refinance once you reach 20% equity and no longer have to make this monthly mortgage insurance payment.
Fixed Rate
The fixed rate or conventional mortgage is definitely one of the most common loan options out there and is frequently referenced when you’re searching online for rates. When you opt for a fixed rate loan, your lender will “lock in” an interest rate, which is the interest rate you’ll pay for the duration of the loan. Conventional loans typically come in 30, 20 or 15 year terms, with shorter term loans generally having a lower interest rate. Most home-buyers will stick to the conventional 30 year loan, however you can often decrease your interest rate by a percentage point or more by selecting a 15 year loan.
With rates being so low at the moment, many homeowners (myself included) have refinanced loans to the point where they can shrink their loan term from 30 years down to 15 years for just a little bit more each month. Carefully weigh your options and consult with a financial advisor to select the loan option that’s right for your situation.
Adjustable Rate (ARM)
Adjustable rate loans or ARM loans are often selected by homebuyers who don’t plan to own the home for the long haul. They’re inherently more risky because the annual interest rate can fluctuate up or down depending on the market. If interest rates go down, you’ll pay less each month, however if they go up, you could certainly be in for a higher than expected mortgage payment. Given interest rates are currently very low, it’s definitely more likely that you’ll experience higher interest rates at some point in the future and will have to account for that in your budgeting if you were to select this loan type.
Federally Backed
FHA or VA loans are a great option for those who do not qualify for a traditional fixed rate loan. While they often have more stringent requirements to qualify, these loans make it easier for first-time homebuyers, veterans, or those with low incomes to be able to purchase a home with little money down.
While these are the most common, there are ultimately many, many different loan types. To choose a loan for your specific situation, it’s best to consult with a financial advisor who can give you the best options to fit your needs. And while this all can sound daunting, the peace of mind and financial security of owning a home is in my opinion absolutely worth it.