For most Americans, buying a home is the biggest purchase they'll ever make.
If you're looking to become a homeowner and can't pay cash, you'll need to know the ins and outs of mortgages. If you already have a mortgage, you may be considering refinancing.
Mortgages consist of two main parts: The principal, or the amount you're borrowing, and the interest, or the amount lenders charge you for lending the money, calculated as a percentage of the principal, or mortgage rate.
Whether you currently own a home or are looking to purchase one soon, interest rates are key. Explore your options and make sure you're getting the best rate possible.
There are two basic kinds of interest rates that govern how most mortgage payments are calculated:
A fixed-rate mortgage (FRM) means the percentage interest you're charged for borrowing the money stays fixed throughout the life of the loan. That helps keep payments steady for long periods of time.An adjustable-rate mortgage (ARM) means the rate charged by your lender moves up or down generally in concert with overall interest rates set by the Federal Reserve. ARMs usually start at a lower rate for a set period of time, then adjust up or down.
Your total monthly mortgage payment can also include escrow, local property taxes, private mortgage insurance, and other service fees.
What kinds of mortgages are there?
There are many kinds of mortgages available and a lot of jargon that comes with them. Here are six:
Conventional loans are the most popular. Consumers with credit scores generally above 680 face fewer fees and less restrictive terms to qualify. These sorts of loans aren't covered by the federal government. You'll need at least 3% down. Lenders also require a monthly private mortgage insurance (PMI) premium if your down payment is lower than 20%. They can be conforming or non-conforming (also known as "Jumbo"). Conforming loans. These loans, such as a typical 30-year fixed rate mortgage, adhere to standards set by Government Sponsored Entities (GSEs) called Fannie Mae and Freddie Mac. In 2022, the baseline conforming loan limit is $647,000 but varies by state and county. Fannie Mae and Freddie Mac don't directly lend to borrowers. Rather, they buy mortgages from lenders, including banks. They were set up in the decades following the Great Depression to spur home ownership and help build wealth. So lenders follow their guidelines for conforming loans. You can explore your loan qualifications easily by answering a few short questions.Non-conforming (Jumbo) loans. If you're looking at a purchase price that requires a mortgage above $647,000, you may need a non-conforming loan. These loans can be more expensive and require higher down payments and credit scores as lenders view them as a higher risk. FHA loans: These loans issued by participating lenders are tailored to lower- and middle-income borrowers and are insured by the government through the Federal Housing Administration (FHA). If you qualify, your down payment can be as low as 3.5%. Credit score requirements are lower than conventional loans. The program also offers counseling to assist you.VA loans: These loans are for veterans and members of the U.S. armed services. Surviving spouses may also qualify. The Veterans Administration offers both direct loans and guarantees for bank loans - with no down payment. VA loans, however, do require a unique funding fee.USDA loans: The Department of Agriculture (USDA) offers mortgages for low- and very low-income applicants from rural areas, both directly and via guaranteed bank loans. Eligibility is based on income, which varies by area. USDA loans don't require a down payment and carry a fixed interest rate.What type of mortgage is most common?
Most U.S. borrowers take out a 30-year fixed-rate mortgage, according to Freddie Mac.
Generally, a 30-year mortgage tends to have lower monthly payments than shorter loans. That makes payments more affordable month-to-month. But that also means you pay a bigger total because there are more interest payments.
Fixed-rate mortgages are typically offered over 10, 15, 20, and 30 years. Refinancings usually have shorter terms, such as 10- or 15-year loans.
How do I know which mortgage is better?
A lot depends on your situation and your goal for the property. Take stock of your overall financial picture and long-term goals to find a mortgage you can afford. Compare ARMs and FRMs to determine what's best for you.
Be sure to include all the monthly bills, your income, and savings for a down payment. In general, you shouldn't spend more than 28% of your monthly income on your mortgage payment. You can also judge offers by using this estimated payment calculator.
Shop around. If you think you qualify, try a government-backed loan. Pay attention to your total cost. That includes all fees, closing costs, escrow, down payment, and insurance. Some experts also advise setting aside three months' worth of payments in case of emergency, like a job loss.
Which type of mortgage should you choose if you want a stable interest rate?
Fixed mortgages provide a stable interest rate for the life of the loan. That means if interest rates rise, you'll keep paying the same rate. If interest rates fall, however, you may want to refinance a fixed-rate mortgage. Remember, refinancing also involves fees, closing costs, and other expenses. Compare your overall costs, not just the monthly payment.
What factors affect monthly mortgage payments?
Many factors make up your monthly mortgage payment. They include general economic conditions (like rising interest rates), your credit rating, length of your loan, income, down payment, savings and other accounts, debts, and the kind of loan you seek. Lenders will ask you to fill out a uniform loan application in addition to financial documentation including proof of income, tax and W-2 records, bank and investment statements, and other assets.
Have more questions? An online financial adviser can help you today.