Finding the home of your dreams probably felt like the hard part – but you still have some important decisions to make about what type of mortgage loan will be best for you.
- The stability of your monthly payment
- Your ability to qualify for the loan amount
- How long you plan to live in the home
- Whether your income is stable or rising
- The possibility of significant interest rate changes
- The amount of up-front costs
- Whether you can comfortably afford your monthly mortgage payment
Your monthly mortgage payment will generally include:
- A principal and interest (P&I) payment
- An amount to cover your real estate taxes and homeowners insurance
- Possibly an amount to cover other costs like condominium dues or mortgage insurance
Fixed-rate vs. nonfixed-rate mortgages
Mortgage loans generally fall into one of two broad categories — fixed-rate and nonfixed-rate.
Fixed-rate mortgages feature a nonchanging interest rate. With a fixed-rate loan, the P&I portion of your monthly mortgage payment does not change. However, real estate taxes and homeowners insurance costs may change from year to year, resulting in a higher or lower monthly payment.
- Advantages: If you don’t expect your income to rise rapidly, you’ll appreciate the comfort of knowing the P&I portion of your mortgage payment will not change.
- Disadvantages: Fixed-rate mortgages typically have a higher interest rate than nonfixed-rate mortgages.
With a nonfixed-rate mortgage, often known as an adjustable-rate mortgage or ARM, you assume some of the interest-rate risk that the lender normally assumes on a fixed-rate mortgage. For taking this risk, you usually receive a lower initial interest rate than the fixed-rate mortgage's interest rate. Nonfixed-rate mortgages are a possible option for borrowers who are comfortable with their ability to handle payment increases. They can also be a good option for folks who are very confident they’ll be staying in the home for a shorter period of time (ideally less than the term of the initial low interest rate).
- Advantages: A lower interest rate means a lower monthly payment. The point at which the payment can be changed varies by the program you choose. It can range from one month to more than five years. Typically, the shorter the period before a change can occur, the lower the initial interest rate.
- Disadvantages: The trade-off with the nonfixed-rate mortgage is that, beyond increasing costs for taxes and homeowners insurance, the interest portion of your monthly payment also increases.
Interest-only mortgages
Some lenders offer interest-only mortgages, although they are not as widely available as they once were. These loans typically do not require any principal payments for a set period of time – typically 5, 7 or 10 years.
With an interest-only mortgage, in the short term, your monthly mortgage payment will be lower because you’re not paying off principal. But you may face a very significant payment increase once the loan begins to amortize (the time at which your payments must cover both principal and interest). Plus, you’ll limit any equity you might build during the interest-only period of your loan because you are making no steps toward paying down your debt. If you are considering an interest-only loan, make sure you clearly understand the terms and are prepared for a steep hike in your monthly mortgage payment.
Mortgage terms options
The term of your loan affects two things:
- Your monthly payment
- Building equity
Equity is a term used to describe the difference between the market value of your property and the amount you still owe. The shorter the loan's term, the higher the monthly payment and the quicker you build equity. Conversely, a longer term results in lower monthly payments, but slower equity build-up.
Down payment options
When considering how much of your savings to use for a down payment, you should also think about your other investment goals, emergency funds and how much money you might need for immediate expenses related to buying your first home. Are there repairs or renovations you want to make right away? Do you need to buy appliances or furniture?
If you decide to make a down payment of less than 20% of your home's value, your lender will most likely require that your loan is guaranteed by one of these entities:
- US Department of Veterans Affairs (VA): If you are a veteran of the US armed forces, check with your lender regarding VA loan possibilities.
- Federal Housing Administration (FHA): There are certain limitations with FHA loans; check with your lender regarding these options. On loans with less than 10% down and terms greater than 15 years, monthly FHA insurance payment cannot be cancelled.
- Private Mortgage Insurance (private MI): MGIC, Readynest’s parent company, is a private MI company – we believe private MI offers several advantages for homebuyers. Mainly, it can allow you to buy a home sooner without the need to save up 20%, which for many of us can take years. It can also increase your purchase power (how much home you can afford), broadening your home-buying options.
There are some differences between private MI and FHA financing:
- Private MI typically requires less money down
- Borrowers with better credit scores typically pay less for private MI than FHA mortgage insurance. FHA mortgage insurance may cost less than private MI for those with lower credit scores.
- FHA financing requires an upfront premium. While Private MI provides an option to pay upfront, the most common type used is known as Monthly MI and does not require an additional amount to be paid at closing or added to your loan. Most borrowers opt to add the FHA upfront premium to their loan amount, increasing their debt.
- Generally, you can request to cancel private MI when your mortgage balance reaches 80% of your home's value — either because you've paid down the balance or because your home's appraised value has increased due to improvements or appreciation. On loans with less than 10% down and terms greater than 15 years, the monthly FHA insurance payment cannot be cancelled.
Learn more about private MI.