In today’s red-hot real estate market, it may seem like getting your offer accepted is the hardest part of buying a home.
But in some cases, that’s actually the easy part. Once you’re under contract, there’s a litany of other decisions you need to make. Choosing the right type of mortgage is one of the most important — it’s a decision that will have financial consequences for the next 15 or 30 years.
What’s the difference between conforming and jumbo loans? Fixed-rate or adjustable? There are so many options to choose from, and in order to make the best financial decision for you and your family, you must understand the differences between each. Use this guide to learn more about each mortgage type and how they might work for you.
Which Type of Mortgage Is Right for You?
First off, there are a lot of factors that go into choosing the right type of mortgage — and surprisingly, some of them have nothing to do with money.
“In order to determine what mortgage type is right for you, focus first on the non-financial aspects of the purchase,” said Gregory Giardino, a financial advisor with J.M. Franklin & Company LLC, a retirement planning financial firm.
Here are some questions you should be asking yourself:
- How long do you plan to live there? Knowing how long you expect to stay in a certain city is important in determining what type of loan to get and how much. “Having an estimate of how long you anticipate staying in your home is critical in determining how to maximize loan terms to your advantage,” Giardino said.
- What are your prospects for job/career security? Is your industry growing or at least stable? “The last thing you want to do is pick the wrong mortgage type because you assumed your industry was immune to change,” Giardino said.
- What is your future earning potential? Do you expect your pay to increase, stay the same, or even decrease? “Your profession’s growth and the earnings potential of your paycheck will influence in the long-term what type of loan is appropriate for your family,” Giardino said.
Once you answer those questions honestly and openly, you can now consider the loan terms and interest rates that are most beneficial to you.
Different Types of Loans
Conventional Mortgage Loan and Jumbo Loans
A conventional loan is the most common type of mortgage, and refers to any mortgage not backed by a government agency. There’s a reason why most buyers end up with conventional loans: Conventional loans have strict lending requirements from banks, so they come with fewer limitations when it comes to income and property type, and they tend to carry lower fees.
“Lenders know them, and they’re pretty competitive,” said Matt Bacon, an investment advisor at Carmichael Hill, a financial advisory firm. “This is like the bread and butter for everything.”
Conventional loans will work for most purchases. Usually, if you put down less than a 20% downpayment, you’ll have to pay private mortgage insurance, which can cost a few hundred dollars a month.
Be aware of the two types of conventional loans: conforming or jumbo. There is an upper limit on the purchase price before a mortgage becomes a “jumbo loan,” which has higher interest rates and stricter requirements. You can use this map to see what the conforming loan limits are in your area.
Fixed Rate Loan vs Adjustable Rate Loan
Mortgages are available with two different types of interest rates: fixed and adjustable.
- On a fixed-rate loan, the interest rate stays the same for the entire life in the loan. That means you lock in the interest rate of today’s market for the next 15-30 years.
- On an adjustable-rate loan, the interest rate varies along with the broader financial market. It’s likely to go up and down over the course of the loan, which could cause big swings in your mortgage payments.
“If you’re looking at that adjustable-rate mortgage, and you’re getting in at what is probably the bottom now, odds are your rates are going to be higher,” Bacon said.
But if you plan to stay in this home for many years, you’ll likely want to lock in a low fixed rate now.
There are a number of government-insured loans that can make homebuying more accessible. You may have heard of VA, USDA or FHA loans, all of which make it easier for some borrowers to qualify for and afford a mortgage.
Depending on your financial situation, a conventional loan isn’t necessarily better than a government-backed loan, Bacon said. Either might work for your income level and housing goals. Certain non-conventional loans carry specific benefits, like the VA loan’s favorable terms for veterans or the USDA’s incentives to buy in rural areas.
Government-backed loans are issued by many of the same lenders who issue conventional loans. Some financial advisors warn that government-issued loans might be less appealing to sellers in today’s hot housing market where cash offers and conventional loans are seen as the most desirable, Bacon said.
Other Types of Mortgages
There are a few other types of mortgages that are less popular, but still available to buyers:
- Interest-only mortgages: This type of loan allows you to pay only interest during a set period of time, after which you need to refinance the loan or start paying higher monthly payments.
- Combination mortgage: Also known as a “piggyback” loan, this allows borrowers to combine two loans and qualify for a higher loan amount.
- Reverse mortgages: Available to homeowners who are 62 and older, this type of loan allows you to borrow against the value of your home without having to make monthly payments.
The right type of mortgage is a decision that will stay with you (and your wallet) for a very long time. Start by understanding your needs (what you can afford, and how long you plan to stay in the home) and then choose the loan that fits you best. Make sure to shop around with different lenders to get the lowest mortgage rates possible. Experts recommend requesting and comparing at least three different quotes before deciding on a lender.