What's the Best Mortgage? | Picking Loans
- Whether you have a FICO score in the 500s or 800s, there are numerous mortgage options that can fit your credit score.
- Mortgages can be as short as five years or as long as 30 years, depending on your ideal loan payment.
- Each mortgage type has its advantages and disadvantages and is a great or bad fit for a particular buyer.
With Spring around the corner and daffodils already in bloom, the house-hunting season is kicking into gear, and with home shopping comes questions about interest rates, credit scores, and how much house you can afford. Thus, finding the right mortgage can help ensure that you finance your home (or even an investment property) under terms and conditions that best meet your current and projected financial situation.
There are a few mortgage types you should consider. Here are five that fit the needs of most homebuyers.
A conventional mortgage is a loan provided to homebuyers who have a FICO score in the high 600s— for some banks as low as 620 and others as high as 680– and have a low amount of debt relative to their income.
The baseline loan limit for a single-family conventional mortgage is $647,200 in most regions, with a cap of $970,800 in high-cost regions.
Conventional mortgages can be used to finance your primary residence, secondary residence, and even a multifamily home of up to four units as long as one of those units is your home-sweet-home. Using a conventional loan to purchase and live in a duplex, triplex, or fourplex allows many aspiring homeowners to fast track their twin objectives of generating additional cash flow and building generational wealth.
Recommended Read: How to Make the Jump from Renting to Buying a Home
Two to four-unit properties have a down payment requirement of as much as 20% versus 3% for a single-family home. However, these properties can also be financed with a larger baseline mortgage of $828,700 for a 2-family, $1,001,650 for a 3-family, and $1,244,850 for a 4-family. It also comes with the benefit of rental income supporting the mortgage payment.
If your credit score is closer to 500, a government-backed mortgage, also called a government-insured mortgage, may best fit you and your needs. The insurer, the Federal Housing Administration (FHA), insures the loan against default, thus reducing repayment risk for the bank and increasing the willingness of lenders to finance borrowers with less than stellar credentials.
Recommended Read: Homeowners Can Get Money From the Homeowner Assistance Fund
While FHA's credit minimums are less stringent than those required for a conventional loan, their down payment requirements are not. For FICO scores between 500 and 579, a down payment of 10% is required. For FICO scores of 580 or higher, a down payment of 3.5% is required. In both cases, homeowners may purchase a 2-4 unit multifamily just as they can with a conventional mortgage.
FHA loans also come with restrictions on private mortgage insurance (PMI) and debt fronts. For example, FHA requires that private mortgage insurance premiums be paid no matter how large a down payment the buyer provides. Conversely, conventional loans require no PMI payments for down payments of 20% or more.
PMI rates currently average 0.6% to 1.9%. Using an example of a 1% PMI rate and a $200,000 mortgage, a 1% premium would add $2,000 a year, or $167 a month, to a monthly mortgage payment, definitely not small potatoes.
FHA also requires that borrowers have a lower percentage of debt relative to income. The maximum debt percentage for FHA loans is 50%, meaning if your annual income is $100,000, your annual debt payments should total no more than $50,000 between your car note, student loans, credit cards, and any other debt payments.
Conventional loans allow a debt percentage of 57%, meaning if your income is $100,000, you can still qualify with annual debt payments of as much as $57,000.
As its name implies, jumbo loans are used to finance very large loans, typically for expensive homes priced above the baseline loan limit of $647,200, or $970,800 in high-cost regions. In much the same way that a lower FICO score increases the riskiness of the loan from the lender's perspective, a jumbo-sized loan adds risk. As such, lenders require a credit score of at least 680-700 and a larger minimum down payment of as much as 20%.
Some lenders also charge a higher interest rate on jumbo loans than on conventional loans and require two appraisals instead of one to confirm the house's value. However, as with conventional loans, jumbo loans can be used for both single-family and multifamily homes.
Fixed Rate Mortgage
Just as the purpose of jumbo rate mortgages is spelled out in its name, so too are fixed-rate mortgages. Fixed-rate mortgages provide an unchanging, fixed rate of interest on the mortgage for the life of the loan. Fixed-rate loans are offered for periods spanning 5 to 30 years, with the typical duration being a 15-year mortgage or a 30-year mortgage.
The fixed-rate for a 15-year mortgage is lower than for a 30-year, as lenders associate a shorter timeframe with lower risk. Likewise, conventional loans' fixed rate is lower than FHA loans as lenders associate a higher credit score with less risk.
Whereas the rate on a fixed-rate loan is stable, the rate for an adjustable-rate mortgage (ARM) can fluctuate with market conditions. How frequently the rate is adjusted depends on the loan terms.
As an example, loans that have an annual reset period will lock in the adjustable rate over the course of the year. Upon the first day of the new year, the lender will then adjust the rate higher or lower in line with the prevailing mortgage rate at that time.
Recommended Read: 10 Tips for Buying a Home or Investment Property on a Budget
The Money Wrap-Up
Conventional loans are best for those whose minimum credit score is between 620 and 680, depending on the lender. Credit scores in this range potentially enable borrowers to qualify for as low as 3% down payment rates.
FHA government-backed loans are a great fit for borrowers with low credit scores. Just bear in mind that with scores of 579 or less, a 10% down payment is required.
Jumbo loans work best for borrowers with excellent credit–think FICO scores of 700 or higher–who will be buying an expensive home.
A fixed-rate loan is an excellent fit for those who desire the predictability of an interest rate that will be the same month after month and year after year, no matter the ups and downs of the global economy.
An adjustable-rate mortgage is most often used when borrowers do not need a 15-year or 30-year fixed mortgage because they intend to sell the home after a few years. In addition, borrowers who believe that sky-high interest rates are bound to come down in the future, which is a risky proposition, will also prefer ARMs.
All mortgage types listed above can be used whether you're buying a single-family home or venturing into the landlord.