By Bob Walsmith Jr.
2022 President
Santa Barbara Association of Realtors
With this super-simple breakdown of loan types, you won’t get overwhelmed, you’ll find the right mortgage.
When it comes to buying a house, most people know what they prefer: a bungalow or a condo, a hot neighborhood or a sleepy street.
Mortgages, too, come in many styles — and recognizing which type you should choose is just slightly more involved than, say, knowing that you prefer hardwood floors over wall-to-wall carpeting.
First things first: To pick the best loan for your situation, you need to know what your situation is, exactly. Will you be staying in this home for years? Decades? Are you feeling financially comfortable? Are you anxious about changing loan rates?
You’ll want to have an understanding of the different loans that are out there. There are lots of options, and it can get a little complicated — but you got this. Here we go.
Mortgages Are Fixed-Rate or Adjustable, and One Type Is Better for You
Let’s start with the most common type of mortgage, that workhorse of home loans — the fixed-rate mortgage.
A Fixed Rate Mortgage:
· Lets you lock in an interest rate for 15 or 30 years (there are also 20 year loans as well). That means your monthly payment will stay the same over the life of the loan. (That said, your property taxes and insurance premiums will likely change over time.)
It’s ideal when: You want long-term stability and plan to stay put.
Here’s what else you need to know about fixed-rate mortgages:
· A 30-year fixed-rate mortgage offers a lower monthly payment for the loan amount (for this reason, it’s more popular than the other option, the 15-year).
· A 15-year fixed-rate mortgage typically offers a lower interest rate but a higher monthly payment because you’re paying off the loan amount faster.
Now let’s get into adjustable-rate, the other type of mortgage you’ll be looking at.
An adjustable-rate mortgage (ARM):
· Offers a lower interest rate than a fixed-rate mortgage for an initial period of time — say, five or seven years — but the rate can fluctuate after the introductory period is over, depending on changes in interest rate conditions. And that can make it difficult to budget.
· Has caps that protect how high the rate can go.
It’s ideal when: You plan to live in a home for a short time or you expect your income to go up to offset potentially higher future rates.
Here’s what else you need to know about adjustable-rate mortgages:
· Different lenders may offer the same initial interest rate but different rate caps. It’s important to compare rate caps when shopping around for an ARM.
· Adjustable-rate mortgages have a reputation for being complicated. As the Consumer Financial Protection Bureau advises, make sure to read the fine print.
A general rule of thumb: When comparing adjustable-rate loans, ask the prospective lender to calculate the highest payment you may ever have to make. You don’t want any surprises.
Conventional Loan or Government Loan? Your Life Answers the Question
Which fixed-rate or adjustable-rate mortgage you qualify for introduces a whole host of other categories, and they fall under two umbrellas: conventional loans and government loans.
Conventional loans:
· Offer some of the most competitive interest rates, which means you’ll likely pay less in interest over the period of the loan.
· Typically you can get one more quickly than a government loan because there’s less paperwork.
Who qualifies? Typically, you need at least a credit score of 620 or above and a 5% down payment to qualify for a conventional loan.
Here’s what else you need to know about conventional loans:
· If you put less than 20% down for a conventional loan, you’ll be required to pay private mortgage insurance, an extra monthly fee designed to mitigate the risk to the lender that a borrower could default on a loan. (PMI ranges from about 0.3% to 1.15% of your home loan.) The upshot: The lender has to cancel PMI when you reach 22% equity in your home, and you can request to have it canceled once you hit 20% equity.
· Most conventional loans also have a maximum 43% debt-to-income ratio, which compares how much money you owe (on student loans, credit cards, car loans, and other debts) to your income — expressed as a percentage.
Fannie Mae and Freddie Mac set limits on how much money you can borrow for a conventional loan. A home loan that conforms to these limits is called a conforming loan:
· In most cities, the maximum amount for a conforming loan is $548,250.
· In high-cost areas, such as New York City and San Francisco, the limit is $822,275.
· Limits are revisited annually and are subject to change based on each area’s average home price.
A home loan that exceeds these limits is called a jumbo loan:
· Jumbo loans typically require a higher down payment (up to 30% for some lenders) and a credit score of at least 720. Some borrowers can qualify while putting down 20%, but their credit score has to be higher.
· They also tend to have stricter debt-to-income requirements, generally allowing for a maximum DTI ratio of 38%.
There are practical considerations to take into account before getting a jumbo loan too, mainly: Are you comfortable carrying that much debt? The answer depends on your current financial situation and long-term financial goals.
There are other types of loans. You should reach out to your trusted REALTOR® for suggestions of lenders to speak with for help.
Bob Walsmith Jr. is a native to Southern California and a Realtor® with Berkshire Hathaway HomeServices California Properties in Santa Barbara. During his work with the Santa Barbara Association of Realtors, Bob has served on the CORE Committee, Education Committee, been Chair of the Budget & Finance Committee, and the Multiple Listing Service Committee. He also is on the Board of Directors of the Alpha Resource Center of Santa Barbara. Bob lives in Goleta with his beautiful wife Julie. When not working, Bob enjoys playing golf, fine wine, fine dining, and walking our beautiful coastline. Bob can be reached at 805.720.5362 and/or bob@bobwalsmithjr.com