When it comes to buying a new home, it's a given that you'll shop around to get the very best value for your money. But have you done the same legwork for your home loan?
"The impact of just a half of a percentage point in interest on a 30-year mortgage is pretty dramatic," says J.J. Montanaro, a certified financial planner™ practitioner with USAA. "That's one reason why you definitely want to shop around for the right loan." Consider this: If you were to buy a $200,000 home with a 5% fixed-rate loan, you would pay about $22,000 more in interest over 30 years than you would if the interest rate were 4.5%.
Other fees to keep an eye on during the loan process are the closing costs, Montanaro says. "Origination fees, title charges, appraisals and even credit checks can vary widely from lender to lender, so it pays to shop around and even negotiate these costs," he explains.
"You should definitely do your homework," says Walter Molony, spokesman for the National Association of Realtors. "Seek reputable lenders, and see what the mortgage rates and lender fees are so you'll be prepared. And get prequalified for the loan you want. That way, you won't waste time."
Keep in mind, too, that just because a lender prequalifies you for a maximum loan amount doesn't mean you should spend that much on your home. In general, Montanaro suggests that your total house payment -- principal, interest, taxes and insurance -- equals no more than 28% of your gross monthly income, and less is better.
"If you overextend yourself and get it wrong with what is possibly your biggest monthly payment -- your mortgage -- it will be hard to fix by cutting back on buying coffee or tightening your grocery spending," he says. "So budget for your loan payment carefully, preferably well before you fall in love with a particular home."
When comparing home loans, two factors to consider are the type of loan and the terms of the loan.
Use the following information to help you choose the appropriate loan for your lifestyle and financial situation.
Which Loan Meets Your Needs?
The three types of common home loans are Veterans Affairs, Federal Housing Administration and conventional. VA and FHA loans are government-backed: If the buyer defaults on the loan, the government ensures full payment to the lender. Conventional loans generally include any loan that is not VA or FHA and aren't insured by the government. In this chart, Montanaro provides descriptions of common home loans, buyers they are suited for and their pros and cons.
| Type | Description | Best for | Pros | Cons |
|---|---|---|---|---|
| VA | Government-insured home loans for veterans, active-duty military personnel or eligible spouses. Loans can go up to $417,000 with 100% financing or even exceed that amount, depending on where the property is located. | Buyers may even meet requirements for other types of home loans. VA loans are an attractive military benefit. | Zero-down, 100% financing for those who qualify; mortgages may be assumed by other military buyers; no monthly mortgage insurance premium required; closing costs limited. | Nonexempt veterans are required to pay a funding fee to the VA to use their VA home loan entitlement. Financing the funding fee into your home loan could mean that you owe more than the value of your purchase. |
| FHA | Government-insured home loans that offer a low down payment. | Borrowers who are making a down payment of less than 5%. | Down payments as low as 3.5%. Allows you to buy a home, repair or restore, and include all the costs in one loan. | Limits on amount loaned; monthly insurance premium usually required in addition to a mortgage insurance premium, paid around the time the loan closes. |
| Conventional | Home loans that are not VA or FHA, including fixed- and adjustable-rate loans, and jumbo loans (loans greater than $417,000, or more in some high-cost areas). | Homebuyers who have a lower debt-to-income ratio and a good credit score; want to borrow more than FHA allows; plan a down payment of 5% or more. | Flexible loan terms with fixed-rate or adjustable-rate options. | Most require a monthly mortgage insurance premium unless the down payment exceeds 20%. |
| Sources: usaa.com. USA.gov, makinghomeaffordable.gov, U.S. Department of Veterans Affairs, U.S. Department of Housing and Urban Development, Federal Trade Commission, U.S. Federal Reserve | ||||
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Military homebuyers should take into account the unique circumstances of serving when choosing a loan. These include their anticipated length of time in the home, which could be considerably less than civilian homebuyers, who often remain in a house 10 or more years.
However, Montanaro advises all buyers -- military and otherwise -- to think long term. And that includes choosing the best terms for whatever type of loan fits your situation
Which Loan Terms Make Sense?
Two factors make up the terms of a loan: the interest rate and number of years you'll have to pay off the loan. Each category of loan -- VA , FHA and conventional -- offers either a fixed rate of interest or an adjustable rate. The life of the loan is usually 15, 20 or 30 years. In this chart, Montanaro provides descriptions of loan rates, buyers they are suited for and their pros and cons.
| Loan Term | Description | Best for | Pros | Cons |
|---|---|---|---|---|
| Fixed rate | Repayment terms of 15, 20 or 30 years; the interest rate and monthly payment stay the same for the life of the loan. | Buyers who want a fixed monthly payment for the life of the loan. (Mortgage payments can fluctuate somewhat as escrow taxes and insurance costs are adjusted annually.) | Little or no change in the monthly payment amount. | Initially, a potentially higher interest rate as compared to an adjustable rate; you must refinance to take advantage of lower interest rates. |
| Adjustable rate | Also known as variable-rate loans. Interest rates change based on market conditions after a fixed period has ended; typically, the loans have one-, three-, five- or 10-year terms before the rates adjust. | Buyers who plan to live in the home short-term or pay off the mortgage before the fixed period ends. | Interest rates usually lower initially than fixed rates; low rates can provide excellent savings early on; usually maximum and minimum interest rates are set. | Once the fixed period ends, you're exposed to fluctuating market conditions, which may result in higher monthly payments. |
| Sources: usaa.com. USA.gov, makinghomeaffordable.gov, U.S. Department of Veterans Affairs, U.S. Department of Housing and Urban Development, Federal Trade Commission, U.S. Federal Reserve | ||||
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In today's low-interest-rate environment, adjustable-rate loans aren't as enticing as they once were, Montanaro says.
"Adjustable-rate loans usually make sense when there's a possibility that rates will decline," he explains. "However, fixed-loan rates remain low right now. That rate stability over the long haul makes them attractive for many buyers."
"Even if you plan to move, you may end up owning the home longer than you expect," he adds. "If you're considering an adjustable-rate loan, you should definitely understand your interest rate adjustments and caps, and ask yourself if you can handle the loan even in a worst-case scenario."
