By Bob Walsmith Jr.
President 2022
Santa Barbara Association of Realtors
Don’t get overwhelmed with this super simple breakdown of loan types, find the right mortgage for you.
When it comes to buying a home, most people know what they prefer: a bungalow or condo, a hot neighborhood or a sleepy street.
Mortgages come in many styles, too — and realizing which type to choose is only slightly more complicated than knowing, say, that you prefer hardwood floors to carpet.
First things first: In order to select the best loan for your situation, you need to have a thorough understanding of your situation. Are you staying in this house for years? decades? Are you financially comfortable? Concerned about the change in lending rates?
You want to have an understanding of the different loans that are out there. There are many options, and it can get a little complicated – but you get that. Here we go.
Mortgages are fixed rate or adjustable, and one type is better for you
Let’s start with the most common type of mortgage, the workhorse of home loans – the fixed-rate mortgage.
A fixed rate mortgage:
· This allows you to secure an interest rate for 15 or 30 years (there are also 20-year loans). This means that your monthly payment stays the same throughout the life of the loan. (That means your property taxes and insurance premiums will likely change over time.)
It is ideal if: You want long-term stability and plan to stay put.
What else you need to know about fixed-rate mortgages:
· ONE 30 year fixed mortgage offers a lower monthly payment for the loan amount (for this reason it is more popular than the other option, the 15-year one).
· ONE 15 year fixed mortgage typically offers a lower interest rate but a higher monthly payment because you’re repaying the loan amount faster.
Now let’s move on to adjustable rate mortgages, the other type of mortgage you will be looking at.
An Adjustable Rate Mortgage (ARM):
· Offers a lower interest rate than a fixed-rate mortgage for an initial period – say five or seven years – but the interest rate may fluctuate after the introductory period is over, depending on changes in interest rates. And that can complicate budgeting.
· Has caps that protect how high the rate can go.
It is ideal if: You intend to live in a house for a short period of time, or you expect your income to increase to offset potentially higher future interest rates.
Here’s what else you need to know about adjustable rate mortgages:
· Different lenders may offer the same initial interest rate but different interest rate caps. It’s important to compare rate caps when shopping for an ARM.
· Adjustable rate mortgages have a reputation for being complicated. As the Consumer Protection Bureau advises, Be sure to read the fine print.
A general rule of thumb: When comparing variable rate loans, ask the prospective lender to calculate the highest payment you might ever have to make. You don’t want surprises.
Classic loan or government loan? Your life answers the question
Whichever fixed or adjustable rate mortgage you qualify for introduces a whole host of other categories that fall under two umbrella terms: traditional loans and government loans.
Conventional Loans:
· Offer some of the most competitive interest rates, which means you’ll likely pay less interest over the life of the loan.
· You can usually get a loan faster than a government loan because there is less paperwork.
Who qualifies? Typically, you need a minimum credit score of 620 or greater and a 5% deposit to qualify for a traditional loan.
What else you need to know about classic loans:
· If you pay less than 20% on a traditional loan, you have to pay private mortgage insurance, an additional monthly fee intended to reduce the lender’s risk of a borrower defaulting on a loan. (PMI ranges from about 0.3% to 1.15% of your home loan.) The bottom line: The lender must cancel PMI when you reach 22% equity in your home, and you can request that it be canceled when you turn 20 achieve % equity.
· Most conventional loans also have a maximum 43% debt-to-income ratio, which compares how much money you owe (on student loans, credit cards, car loans, and other debt) to your income—expressed as a percentage.
Fannie Mae and Freddie Mac put limits on how much money you can borrow on a traditional loan. A home loan that meets these limits is referred to as an a compliant loan:
· In most cities, the maximum amount for a compliant loan is $548,250.
· In high-price areas like New York City and San Francisco, the limit is $822,275.
· Limits are reviewed annually and are subject to change based on each area’s average home price.
A home loan that exceeds these limits is referred to as an a Jumbo Loan:
· Jumbo loans typically require a higher down payment (up to 30% with some lenders) and a minimum credit score of 720. Some borrowers may qualify if they deposit 20%, but their credit score must be higher.
They also tend to have more stringent debt-to-income ratio requirements, generally allowing a maximum DTI ratio of 38%.
There are also practical considerations to consider before taking out a jumbo loan, most notably: are you comfortable carrying that much debt? The answer depends on your current financial situation and your long-term financial goals.
There are other types of loans. You should contact your trusted REALTOR® for suggestions on lenders to speak to for help.
A native of Southern California, Bob Walsmith Jr. is a Realtor® at Berkshire Hathaway HomeServices California Properties in Santa Barbara. While working at the Santa Barbara Association of Realtors, Bob served on the CORE Committee, Education Committee, Chair of the Budget & Finance Committee, and the Multiple Listing Service Committee. He is also on the Board of Directors for Santa Barbara’s Alpha Resource Center. Bob lives in Goleta with his beautiful wife Julie. When not working, Bob enjoys golf, fine wine, good food and walking our beautiful shoreline. Bob can be reached at 805.720.5362 and/or [email protected]
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