Purchasing your first home is an exciting milestone. But navigating the maze of mortgage options can feel daunting for any first-time homebuyer. With so many loan types and terms to weigh, how do you determine the best home loan for your needs?
This comprehensive guide on home loans breaks down everything you need to know. We’ll explore popular mortgage programs, interest rates, eligibility criteria, down payments, and tips for securing the ideal financing. Whether you’re buying your starter home or dream house, read on to find your perfect match!
Mortgage Loan Types Explained
When starting your homebuying journey, one of the first steps is deciding whether to pursue a conventional or government-backed loan. Let’s dive into the key differences between these two major categories.
Conventional Home Loans
Conventional mortgages are issued by private lenders like banks, credit unions, and mortgage companies. They adhere to guidelines established by Fannie Mae and Freddie Mac and are not part of any government housing program.
Pros:
- Competitive interest rates
- Fixed and adjustable terms available
- Qualify with good credit and income
Cons:
- Typically require 10-20% down payment
- Stricter credit standards than government loans
Conventional loans come in two primary flavors:
Fixed-Rate Mortgages
The interest rate remains unchanged for the full loan term, which is usually 15 or 30 years. This provides payment stability, since your principal and interest payment stays the same each month.
Adjustable-Rate Mortgages (ARMs)
You start with an initial fixed interest rate for 3-10 years. After that set period, the rate converts to an adjustable rate tied to market indexes. Your payment adjusts up or down accordingly.
ARMs offer lower initial rates but also carry risk if rates trend higher long-term. Make sure to understand the caps on rate/payment increases.
Government-Backed Home Loans
Agencies like FHA, VA, and USDA administer special mortgage programs designed to help buyers, especially first-timers, afford a home.
Pros:
- Down payments as low as 0-3.5%
- More flexible credit requirements
- Special help for rural buyers, veterans, and Native Americans
Cons:
- Mortgage insurance and funding fees required
- Lower loan limits than conventional mortgages
Types of government-backed loans include:
FHA Loans
With an FHA loan, you can buy a home with just 3.5% down and a 580 minimum credit score. They are popular with first-time buyers. But you will pay an upfront mortgage insurance premium and ongoing monthly premiums.
VA Loans
VA loans help active duty military, veterans, and surviving spouses buy a home with no down payment required. Closing costs can also be rolled into the loan. VA loans necessitate a funding fee, which varies by down payment amount and service history.
USDA Loans
For buyers in designated rural and suburban areas, USDA loans offer 100% financing. Income and credit standards are flexible, and no private mortgage insurance is needed. You pay an upfront guarantee fee and ongoing annual fee for this zero down payment option.
Key Factors in Selecting a Home Loan
When deciding between mortgage programs, you’ll need to consider several key factors based on your financial situation and homebuying goals.
Interest Rates
Lower rates directly translate into thousands of dollars in interest savings over the loan repayment period. Compare both fixed and adjustable rate options through multiple lender quotes. Ask each lender about buying discount points to lower your rate further.
Even a 0.5% difference in APR can have a noticeable impact, especially on a larger loan amount. To find the best deal, compare the Annual Percentage Rate (APR), not just the interest rate.
Loan Fees
Conventional loans mainly charge origination and appraisal fees. But government programs add on mortgage insurance premiums, guarantee fees, and funding fees. Ask lenders if they offer lender credits to offset closing costs.
Shopping around helps you get the best rates for the lowest fees. Just be sure to compare Quote A to Quote B in writing, with all the same loan terms.
Credit Score Requirements
The higher your credit score, the better mortgage terms you can expect to qualify for. Here are general credit score guidelines:
- Conventional loans: 620 minimum, with 740+ ideal
- FHA loans: 580 minimum
- VA loans: 620 minimum
- USDA loans: No minimum; may accept non-traditional credit
Improving your credit score before applying for a mortgage can expand your financing options. Aim for at least a 720 FICO score.
Down Payments
Down payment requirements vary significantly by loan type:
- Conventional loans: 10-20% recommended to avoid PMI
- FHA loans: 3.5% down payment minimum
- VA loans: 0% down payment required
- USDA loans: 0% down payment required
Come prepared with a down payment cushion. Many conventional lenders allow down payments as low as 3% with acceptable credit scores and debt-to-income ratios.
Homebuying Goals
Think about your overall timeline and budget. Are you looking for lower monthly payments now even if rates rise later? Or do you want payment stability so you can budget confidently?
How long do you plan to stay in the home? Adjustable-rate mortgages may make sense if you expect to move again in 3-5 years. Or opt for the reliability of a fixed-rate loan if you plan to live in your home for decades.
Ask yourself these key questions as you assess lenders and loan products. There’s no one right mortgage for everyone—it depends on your personal financial situation and priorities.
Finding the Best Mortgage Rates
With an overview of loan options and costs, it’s time to start gathering actual rate quotes. Even a 0.125% variance in APR can shift monthly payments by $50-100.
Follow these tips for scoring rock bottom mortgage rates:
Check for daily rate reports on sites like Bankrate and Nerdwallet. Use their mortgage calculator to estimate payments.
Get at least 3-5 quotes from local banks, credit unions, and online lenders. Compare offers side-by-side.
Ask each lender about discount points for buying down the rate and lender credits to offset fees.
Compare quotes using the same parameters: loan amount, down payment, credit score, and loan type.
Select a competitive rate, then ask other lenders to beat or match it. Negotiate for your best deal.
Lock in your rate once you’ve shopped thoroughly and found the right match. Rates fluctuate daily.
Today’s low rate environment offers an opportune time for savvy homebuyers to capitalize on savings. The more quotes you gather, the better your chances of securing rock-bottom rate.
Which Home Loan is Right for You?
Now let’s connect all the dots. Given your financial situation, which mortgage programs should you focus on in your home search?
First-Time Homebuyers
If you’re buying your first home, government-backed loans allow you to get started with minimal out-of-pocket funds. FHA, VA, and USDA loans offer low or no down payment options. Just be ready for the additional mortgage insurance costs.
Stick to a fixed-rate loan for predictable payments as you budget for the many new expenses of homeownership. And look into down payment assistance programs available in your state.
Low Down Payment Buyers
Don’t let down payment hurdles hold you back. With an FHA loan, you can buy a home with just 3.5% down. VA and USDA loans require zero down.
Just make sure to factor mortgage insurance premiums and funding fees into your monthly payments. And work on saving up at least 10% down over time to avoid ongoing PMI costs.
First-Time Homebuyers with Credit Challenges
Imperfect credit doesn’t have to stop you from buying. FHA loans allow credit scores as low as 580 with 10% down. VA and USDA loans can also offer more flexible credit guidelines.
Spend the next 6-12 months improving your credit score. An extra 20-30 points can help you qualify for much better mortgage rates. Show disciplined credit behavior and pay down balances.
Self-Employed or Gig Workers
Showing steady income can be trickier when you don’t have a W2 job. Conventional loans verify your earnings potential through tax returns and bank statements.
But FHA, VA, and USDA loans can offer more flexibility for self-employed buyers. Just be prepared to provide proper income documentation. An experienced mortgage broker is key.
Move-up and Jumbo Loan Buyers
If you need a loan exceeding $510,400 (the 2022 conforming limit), you’ll apply for a jumbo mortgage. Jumbos require higher