Choosing the right home mortgage is as important as choosing the right house. Learn about loan program options and how to decide which is best for you.
Choosing a mortgage can be confusing for first-time home buyers. If you don't understand the differences, it can seem like it is harder than even finding the right home.
But the decision of which type of mortgage you choose should be carefully weighed, as your mortgage plays an important role in your investment. In most cases, you’re on the hook for the payments for decades – usually up to 30 years – and the difference in the type of mortgage you choose can translate to thousands of dollars spent or saved.
Below, we describe the most common home loan programs and how they work.
Conventional Loans
The most common choice is a conventional loan, a non-government backed financing program offering competitive interest rates. You can choose between fixed and adjustable rate terms, and Private Mortgage Insurance (PMI) which you can cancel after you owe less than 80 percent of the home’s value.
In order to qualify for a conventional loan, you must have:
- A reasonably good credit score, around 680 or higher
- Cash available for a down payment - minimum between 3 percent (for first-time homebuyers) and 5 percent
- A maximum of 36 percent debt-to-income ratio (comparison of your monthly debts to your gross monthly income)
- Stable income and employment for 2 years
- No recent bankruptcies or foreclosures
If you put less than 20 percent down, you’ll pay PMI until your balance is less than 80 percent of the value of your home. At that point, you can cancel it. Your credit score will have a significant impact on your interest rate, so you'll want to do whatever you can to boost your score before applying.
Federal Housing Administration (FHA) Loans
The FHA Loan program is a government-backed loan program for approved lenders. If an FHA borrower defaults, the FHA pays lenders back a portion of the funds they lost. These loans have competitive interest rates and flexible guidelines, and may be available to people with lower credit scores. One additional restriction on this type of loan is that it can only be used to purchase a primary residence.
How To Qualify for an FHA loan
To qualify for a Federal Housing Administration loan, you must have:
- A minimum 500 credit score
- At least 3.5 percent of the purchase price available in cash for a down payment if your credit score is over 500. If your credit score is between 500 and 579, you may be approved with a 10 percent down payment
- Maximum 43 percent debt-to-income ratio (comparison of your monthly debts to your gross monthly income)
- Stable income and employment for 2 years
- Proof that you’ll live in the home as your primary residence
- No recent bankruptcies or foreclosures
FHA loans have an upfront funding fee equal to 1.75 percent of the loan amount and annual mortgage insurance equal to 0.85 percent of the outstanding principal balance. The mortgage insurance lasts for the loan’s term.
Veteran's Affairs (VA) Loans
The VA backs mortgage loans for active and inactive military personnel. If the borrower defaults on the loan, the VA will pay the lender back a portion of the funds they lost. The FHA offers competitive interest rates and flexible guidelines. Like an FHA loan, the VA loan is only available if you're purchasing a primary residence.
In order to qualifying for a VA loan, you must have:
- A minimum 620 credit score (this varies by lender)
- Optional down payment – none is required
- Maximum 43 percent debt-to-income ratio (comparison of your monthly debts to your gross monthly income)
- Stable income and employment for 2 years
- Proof that you’ll live in the home as your primary residence
- No recent bankruptcies or foreclosures
- Meet the disposable income guidelines for your area and family size (which are detailed in the VA guidelines)
VA loans don’t charge mortgage insurance, but veterans pay an upfront funding fee equal to 2.3 percent of the loan amount.
United States Department of Agriculture (USDA) Loans
The USDA offers mortgage loans specifically for low to moderate-income families. If the borrower defaults, the USDA pays the lender back a portion of the funds they lost. The USDA offers affordable rates and flexible guidelines for those buying a home in a rural area.
To qualify for a USDA loan, you must meet the following qualifications:
- Minimum 640 credit score
- No down payment required
- Maximum 41 percent debt-to-income ratio (comparison of your monthly debts to your gross monthly income)
- Stable income and employment for 2 years
- Proof you can’t qualify for any other loan program
- Proof that you’ll live in the property as your primary residence
- No recent bankruptcies or foreclosures
- Buy a home in a USDA approved rural area
Choose your loan based on your credit score and down payment amount. Get quotes from at least 3 lenders to compare your options and choose the loan with not only the lowest interest rate but the loan with the lowest costs over the entire term.