Loan Rates Hit 20-Year Highs
Mortgage loan rates have just hit 20-year highs, as the Federal Reserve continues to make consecutive rate hikes in an attempt to curb inflation. For some perspective, just one year ago the benchmark 30-year fixed-rate mortgage was averaging a little over 3 percent—the average rate on 30-year mortgages is now around 7 percent.1 With this large increase in mortgage loan rates year over year, it can seem daunting to borrow. Regardless, how do you know what kind of loan to choose if you are looking to buy or build a home? Well, let’s take a look at your options to help you make the best decision.
The Loan Options For a Mortgage
There are over a dozen different kinds of mortgage loans to choose from and even more lenders that offer them. But even with lots of choices, there are five primary types of loans that suit the needs of the majority of prospective homebuyers. These main kinds of loans are: conventional, jumbo, government-insured, fixed rate, and adjustable rate.
Conventional loans are not backed by the federal government and can be either conforming or non-conforming. Conventional loans can be used for homes and investment properties. The overall borrowing costs tend to be lower than other types of mortgages, and private mortgage insurance can be canceled once you reach 20 percent of equity.
Some downsides to conventional loans are their general requirements of a credit score that is 620 or higher, higher down payments than government loans, and stringent debt-to-income ratio parameters.
Jumbo loans are used to purchase more expensive properties. If you want to borrow for more than the Federal Housing Administration (FHA) borrowing limit, you’ll need this type of loan. In 2022, the borrowing limit set forth by the FHA is $647, 200 in most parts of the US. In areas with a higher cost of living, such as Alaska, Hawaii, Guam, and the US Virgin Islands, the limit has been increased to $970,800. A jumbo mortgage is for an amount higher than these limits.2
A jumbo loan is advantageous when trying to purchase a home that is pricier than the average. But to qualify for a jumbo loan, you’ll likely need a down payment of 10-20 percent, FICO credit score of 700 or more, and display proof of significant assets.
The FHA, USDA, and VA are the three government agencies that back mortgages. These loans help Americans with lower incomes and veterans become homebuyers, as they generally have lower down-payment and credit score requirements. If you can’t qualify for a conventional loan, government-issued loans can be a solution.
The drawbacks to these kinds of loans are often mandatory insurance premiums, lower borrowing limits, and the chance of having overall higher borrowing costs.
A fixed-rate mortgage loan is one which locks in the interest rate at signing for the duration of the loan. For example, if you get a 30-year mortgage, you’ll have the same interest rate in 30 years as you did on your very first mortgage payment, regardless of market interest rate fluctuations.
Fixed-rate mortgages make it easier to budget, as you know your exact monthly payment. When interest rates are low, you can also lock in a good rate. But if interest rates are high, like they are now, it can seem like a lesser than ideal circumstance. It is important to remember you have the option to refinance when mortgage rates come down.
Adjustable Rate Mortgage (ARM)
Adjustable rate mortgages (ARM) use the opposite logic of fixed rate mortgages. These loans have interest rates that fluctuate with market conditions.3 Many ARM mortgages have a fixed interest rate for a few years before the loan changes to a variable interest rate for the remainder of the term. For example, you might see a 5-year/1-year ARM, which means that your rate will remain the same for the first five years and will adjust each year after that initial period. It is important to read the fine print when signing these kinds of loans.
If you don’t plan to stay in your home beyond a few years, an ARM can be a good choice to help save money on early interest payments. However, it’s important to understand the risk that your payments could rise after the initial period.
So, What Is the Best Mortgage Loan Right Now?
As a good financial advisor will say, your own situation really determines which course of financial action makes the most sense. This is especially true when taking out a mortgage to buy a home, as this is usually the biggest financial obligation Americans make.
With the current period of increasing interest rates, the best mortgage loan is the one which suits your financial needs best. If you can accept some risk or are not planning to live in your home for longer than a few years, an ARM mortgage can allow you to save some money in the short term. If you want to buy a more expensive home, then the jumbo loan will help you. Or, if you find your dream home and are ready to make the purchase, a conventional mortgage with a fixed rate should suit you just fine. Besides, with a fixed-rate mortgage, there is the option to refinance when interest rates go lower and save you money.
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- Ostrowski, J. (n.d.). Mortgage rates shatter 7% mark. Bankrate. Retrieved October 27, 2022, from https://www.bankrate.com/mortgages/analysis/
- Tarpley, L. G. (n.d.). What to know about the 13 types of mortgage loans you can get to buy a Home. Business Insider. Retrieved October 27, 2022, from https://www.businessinsider.com/personal-finance/types-of-mortgage-loans
- Marquit, M. (n.d.). 5 types of mortgage loans for homebuyers. Bankrate. Retrieved October 27, 2022, from https://www.bankrate.com/mortgages/types-of-mortgages/#fixed