Before purchasing a home, it's important to explore the different types of loans available to you. Understanding which loan fits your needs can help reduce unnecessary costs.
Following are three options when searching for a home mortgage. However, remember that loans come in many flavors. So, it's a good idea to speak with your lender, who can help you zero in on the loan that's best for your needs.
FHA home loan
A Federal Housing Administration loan is a loan insured by the federal government against defaults. The government insures FHA loans to reduce the lender's risk in case the borrower does not repay the loan.
Generally, it's easier to qualify for an FHA loan than it is for some other types of loans. FHA loans:
- Typically are available with a low down payment.
- Do not require a borrower's credit score to be perfect.
- Often are a great choice for first-time homebuyers.
An FHA loan has many advantages. However, borrowers are required to pay mortgage insurance premiums to help protect the lender in the case of a default.
Conventional fixed-rate loan
Another type of loan is a fixed-rate loan offered by a private lender. Typically, these fixed-rate loans are called conventional loans. This type of loan requires buyers to:
- Provide a bigger down payment, often between 5 percent and 20 percent.
- Have stronger credit than required for an FHA loan.
- Be able to document income and assets.
Borrowers usually must have more cash reserves to qualify for a conventional loan compared with an FHA loan. In addition, borrowers must be able to verify income through W-2 statements, bank statements, tax returns and other financial documents.
An adjustable-rate mortgage, or ARM, typically begins with a fixed rate for a period of time. This rate is often lower than rates charged by typical fixed-interest loans.
However, over time, payments may increase. Rates on ARMs typically reset at a predetermined date. For instance, a 5/1 ARM means that the payments will remain the same for the first five years, before payments begin to adjust annually thereafter.
The new rate could go up or down, depending on what happens to the index to which the loan is tied. Many ARMs have lifetime caps that limit the amount a rate can rise over time.
Kemberley Washington is a certified public accountant and professor at Dillard University in New Orleans. She writes a personal finance blog at Kemberley.com. Follow her on Twitter @kemwashcpa.