How To Choose the Right Mortgage
With so many mortgage types to choose from, you as a first-time homebuyer might be asking, “What type of mortgage should I get?” You’ll find the answer as you learn about the options and understand your priorities.
Here are some steps to take and questions to ask yourself to help you find the best type of mortgage loan for you.
Review Your Finances
The first step toward choosing a mortgage is to understand what you can afford.
Check your credit score
Your credit score affects whether you’re approved for a home loan at all, and the interest rate you’re offered if you do qualify. Borrowers with higher credit scores usually get lower interest rates, and those with lower scores get higher interest rates. A conventional conforming loan requires a credit score of at least 620, while loans backed by the Federal Housing Administration can be had with a credit score of 500 or higher.
Figure out your debt-to-income ratio
Your debt-to-income ratio is a percentage that shows how much of your income is needed to pay your debts each month. Calculate your DTI ratio by adding up all your monthly debts and dividing that figure by your gross monthly income. According to the Consumer Financial Protection Bureau, lenders often require a DTI ratio of 36% or less, though some lenders will approve your application with a DTI ratio as high as 43%.
Don’t forget closing costs and ongoing expenses
Your mortgage isn’t the only expense involved in owning a home. You’ll have to pay closing costs to get your loan funded and transfer ownership of the property. That usually costs between 2% and 5% of the sale price. Then there are ongoing maintenance and repair costs, as well as property taxes, insurance, and possibly homeowners association fees you also will need to budget for.
Ask Yourself 6 Key Questions
Now that you have a good picture of your finances, it’s time to start down the path to the right mortgage by asking yourself six important questions.
1. How much of a down payment can I afford?
Saving for a down payment can be the biggest barrier to homeownership. A down payment that’s at least 20% of the purchase price of the home will reduce your monthly payment and your overall costs. But that’s not required. Conventional loans only require a down payment of 5%, and some lenders go as low as 3%, though putting down less than 20% means you’ll have to pay for mortgage insurance.
If you qualify, some government-backed loans require no down payment.
2. How long of a loan term do I want?
The most common loan terms are 30 years and 15 years, though custom options are available. A longer term lowers the monthly payment because you have more time to pay off the loan, but often comes with higher interest rates and a higher total cost. Shorter loan terms can get you a lower interest rate and a lower total cost, but you’ll have a higher mortgage payment to make each month.
3. Am I comfortable with my interest rate changing?
A fixed-rate mortgage gives you predictable monthly payments for the full term of your loan. Adjustable-rate mortgages often have lower interest rates for an introductory period of three, five, or seven years, after which the interest rate changes periodically. If you choose an ARM, you’ll need to be ready for the interest rate and your monthly payment to increase.
4. How secure is my financial situation?
It may be one thing to afford your mortgage now, but you need to make payments on it for the next 15 or 30 years. If business has been good, but isn’t guaranteed to stay that way, you should be cautious with what you take on. If your income drops, you lose your job, or your financial situation changes enough to make your mortgage payment unaffordable, you could lose your home.
5. How long do I plan to live in the home?
If you plan on living in the home for only a little while, then an adjustable-rate mortgage could offer a lower interest rate in the short term. If you plan on living in the home for the foreseeable future, a fixed-rate mortgage will protect you against interest rate increases and could save you money.
6. Do I qualify for a government-backed mortgage?
Loans backed by the federal government are less risky for lenders and therefore offer favorable terms to specific types of borrowers:
- FHA loans are available to borrowers with credit scores as low as 500, and offer down payments as low as 3.5%.
- Veterans Affairs loans can make homeownership more attainable for military service members, veterans, and their surviving spouses.
- If you live in a rural area and meet certain income requirements, you could qualify for a loan backed by the Department of Agriculture.
Narrow Down Your Choices
Your answers should help you narrow down the type of mortgage that will work best for you. Now it’s time to get specific and find the right loan for you.
Get preapproved for a mortgage
Mortgage preapproval will help you be ready to buy when you find the right home, and shows agents and sellers that you’re a serious buyer. You’ll supply a lender with some financial documents, and the lender will give you a letter that estimates the details of the loan it expects to offer you.
Preapproval letters typically are valid for 30 to 90 days, so you’ll want to wait until you’re ready to buy to get one.
Find a home to buy
Shop around for a mortgage
You don’t have to commit to the first lender who preapproves you. Be sure to compare offers from multiple lenders to ensure you’re getting the best deal possible. You also could consider working with a mortgage broker who can help you find the right loan for your financial situation.
Choose the loan that best fits you and the property
Once you’ve found the house you want to buy and decided on a lender and a mortgage, it’s time to make it official. After you apply, your lender will verify your income and assets and — if everything checks out — you’ll be one step closer to being a homeowner.