Mortgage 101: Choosing a Home Loan
Choosing the right home loan is a critical step in the home-buying process. Many factors will affect your ability to qualify for a home, afford your monthly payment and build equity. Knowing how much you will pay for your mortgage and the best loan for your situation is essential. Here are five factors to consider when choosing a loan.
1. INTEREST RATE
Simply put, interest rate is the percentage of the principal loan balance you pay a lender in exchange for borrowing money. Interest rates are the topic du jour as they have risen steeply since the historic dips of the covid pandemic. Keep in mind today’s interest rates are close to U.S. 20-year averages.
Interest rates will vary by the type of home you are buying and if you’ve bought before. For example, primary-home buyers—especially first-time buyers—will receive rate discounts. Secondary-home buyers and investment buyers will pay higher interest rates.
Your credit score will also affect your interest rate. Those with higher credit scores will receive rate discounts. Lower credit scores will have higher rates. An interest rate may be lowered by buying down points paid by the seller or the buyer at closing. Or if your credit score is detrimentally low, you may want to take some time for credit repair before buying a home.
Term is the length of time over which the cost of paying off your loan (interest and loan amount) is amortized. The most common term in a home mortgage is 30 years. Those looking to pay their loan off more quickly and pay less interest will choose a 15- or 20-year term. A shorter term typically results in a lower interest rate and higher monthly payment. More interest is always paid as part of your monthly payment in the first years of the loan. Equity builds as the years go by until eventually the majority of your payment goes towards equity at the end of the term.
3. INTEREST RATE VARIABILITY
Rates can be fixed, meaning they don’t change over the term of your loan, or variable, meaning they go up or down based on the index (such as the T-bill) they are tied to. A fixed rate is the most common mortgage type and your monthly payment will not vary over the term of your loan.
Adjustable rate mortgages (ARMs) are growing in popularity. The introductory rate is usually lower than the 30-year fixed mortgage rate and you may save money in interest and equity during the fixed-rate period. Compared to their early 2000s subprime counterparts, today’s ARMs meet qualified mortgage (QM) standards. Rate changes cannot exceed initial, periodic and lifetime caps.
4. DOWN PAYMENT
Another deciding factor when determining how much your home loan will cost is down payment. The more you put down, the safer the loan is for the lender. Hence, putting more down will decrease your interest rate, the loan amount and your monthly payment. There are many options if you don’t have a 20% down payment, but those options typically require additional mortgage insurance (PMI) and are more expensive. The U.S. government and State of Utah offer down payment assistance and grants as do some employers.
5. CLOSING COSTS
The fees and expenses associated with taking out a mortgage are part of your loan’s closing costs. These costs may include loan origination fees, discount points and buy down fees, appraisal fees, title searches, title insurance, surveys, taxes, deed recording fees, and credit report charges. Lenders are required to disclose all your closing costs in a loan estimate. This allows you to compare costs and prepare yourself for the cash you will need to close your loan. Some buyers choose to roll their closing costs into their loan amount.
6. LOAN TYPE
The type of loan you choose depends largely on your loan amount and government programs you may qualify for. Mortgages are considered either conforming or non-conforming loans.
A conventional loan, i.e. conforming loan, is the most common mortgage and is backed by Fannie Mae (FNMA) or Freddie Mac (FMCC). These government-backed securities have strict regulations on your qualifying credit score and debt-to-income (DTI) ratio. You can buy a home with as little as 3% down on a conventional mortgage and your credit score can drop to 620 to qualify, but will result in paying Primary Mortgage Insurance (PMI) and a higher interest rate.
- Lower fees and interest rates.
- Low down payment, as low as 3% for qualifying loans.
- Fixed-term and variable-rate ARM options.
- PMI is required if down payment is less than 20%.
- Stricter credit score and DTI requirements.
- Loans cannot exceed county limits which change from year to year.
*In Salt Lake, Davis and Utah County, 2023
Jumbo Loan (i.e. Non-Conforming Loan)
A jumbo loan exceeds the loan limits set by FNMA and FMCC. Jumbo loan limits vary county by county. Jumbo loans are issued by private financial institutions willing to bear the risk of a higher loan amount. This higher risk also translates to stricter lending guidelines.
Jumbo loan rates often vary from conforming interest rates. Whether it is a fixed-rate or an adjustable rate mortgage (ARM), these loans are issued by publicly traded institutions. Thus, jumbo interest rates and products tend to adjust quickly to market demands.
- Higher loan limits.
- Rates are often lower than conventional-loan rates.
- Fixed-term and variable-rate ARM options.
- Require 20% or more down payment and a high credit score.
- Higher closing costs.
Government-backed home loans and payment programs benefit those who have served our country and provide affordable housing opportunities to all. Here is a brief description of some of these programs.
VA loans are available to service members, veterans, and surviving spouses of veterans who meet eligibility requirements. Those with a VA loan certificate of eligibility (COE) will request a VA appraisal of the home and determine whether to finance the purchase based on your credit and income information.
- No down payment or mortgage insurance required.
- Lower interest rates and closing costs.
- Easier to qualify and rebound from financial loss.
- VA jumbo loans are available.
- You won’t pay for mortgage insurance but you will pay a funding fee (unless you are disabled) that varies based on your down payment.
- Property restrictions.
- Less flexibility for waiving contingencies.
The Federal Housing Administration (FHA) offers loans to those who have limited funds for a down payment, poor credit, or a high debt-to-income ratio.
- Low closing costs and down payments (as little as 3.5 percent), credit scores as low as 580 and DTI ratios up to 50 percent.
- Pay both an upfront mortgage insurance premium (1.75 percent of the loan amount), as well as an annual mortgage insurance premium (anywhere from 0.45-1.05 percent).
The Department of Agriculture offers guaranteed and direct loans for homes in designated rural areas.
- Option of zero down payment, lenient credit requirements, competitive interest rates, 100 percent financing, low monthly mortgage insurance premiums.
- Income and residency limits.
- Limited to rural areas.
Other Government Assisted Loans
Utah has its own home assistance program that helps first-time homebuyers with down payment assistance and closing costs. HUD-sponsored programs offer law enforcement officers, pre-K through 12th grade teachers, firefighters, and emergency medical technicians a 50 percent discount from the list price for single-family homes in revitalization areas.
Cori Pugsley is a Mortgage Advisor with Movement Home Loans, a locally-owned and operated mortgage brokerage offering nationally-competitive rates, astute counseling and reliable closings. Contact her with questions or to apply for a loan.