Guest post by TJ Freeborn, Discover Home Loans
If you’re like most homebuyers, you’ll probably take out a loan to finance your purchase. But which home loan is right for you? Having a firm understanding of the types of loans available and the advantages of each is the best way to prepare yourself to begin the home-buying process and find the right loan for you.
What’s in a Home Loan?
It is important to first understand all the components of a loan. Mortgages are generally made up of three parts: principal, interest and fees. The principal is the amount of money you borrow, the interest is the ongoing cost you pay to borrow and the fees are the upfront cost. Depending on the loan you choose, the lender may also collect property taxes and homeowners insurance through your monthly mortgage payment. In these instances, they are held in an escrow account and then paid on your behalf when payments are due.
Types of Home Loans
Home loans typically fall into two primary categories, fixed rate and adjustable rate.
In a fixed-rate mortgage, the interest rate on your mortgage is locked in. You pay the rate for the life of the loan and your monthly principal and interest payments stay the same, regardless of what happens to nationwide interest rates. It is important to note that a fixed-rate mortgage may have a slightly higher interest rate than an adjustable-rate loan because you pay for the security of having a locked rate and a monthly payment that will not change. This type of loan is best suited for homebuyers who want to avoid the uncertainty of fluctuating payments or those that are planning to stay in their home for a long period of time
With an adjustable-rate mortgage, also referred to by its acronym ARM, your monthly mortgage payment depends on the current interest rate in the where your loan was issued. Interest rates go up and down periodically based on the market, which means your payment amount may increase or decrease. Typically, ARMs have a lower initial interest rate than a fixed-rate mortgage and sometimes lock in an interest rate after an initial payment period (usually between a year and 10 years). ARMs may be preferred for buyers who do not plan to stay in their homes for a long period of time and want to save more money in the short run.
If you’re considering an ARM, ask your mortgage banker what your monthly payment will look like if the interest rate increases by 1, 3 or even 5 percent. Knowing what you could be paying down the road will help you have a clear picture of how your household budget may change with interest rates
Whichever loan you choose, you may be able to take advantage of government loan programs offered by the Federal Housing Authority (FHA). These programs often are easier to qualify for, feature lower down payments and offer flexible credit requirements.
When choosing a loan, it’s important you feel confident with the decision you make. If you are not ready to talk to a mortgage banker, you can use online tools, such as Discover Home Loans’ online calculators, to help you better understand your potential options. Read more about mortgage types on the Redfin Home Buying Guide.
About TJ Freeborn and Discover Home Loans
TJ Freeborn is a mortgage professional at Discover Home Loans, where she confers with mortgage bankers and consumers to understand current industry trends and consumer-facing lending issues. Discover Home Loans, a subsidiary of Discover Financial Services, is a source for consumers seeking prime variable- and fixed-rate conventional, FHA and HARP home loans from a trusted name in the financial services industry.
Note: This is a guest post; the views and opinions expressed are those of the author and do not necessarily reflect the opinion or position of Redfin.