Understanding Loan Options

Loan term

30 YEARS, 15 YEARS, OR OTHER

The term of your loan is how long you have to repay the loan.

This choice affects:

  • Your monthly principal and interest payment
  • Your interest rate
  • How much interest you will pay over the life of the loan

Compare Your Loan Term Options

Shorter Term:

  • Higher monthly payments
  • Typically lower interest rates
  • Lower total cost

Longer Term:

  • Lower monthly payments
  • Typically higher interest rates
  • Higher total cost

In general, the longer your loan term, the more interest you will pay. Loans with shorter terms usually have lower interest costs but higher monthly payments than loans with longer terms. But a lot depends on the specifics – exactly how much lower the interest costs and how much higher the monthly payments could be depends on which loan terms you’re looking at as well as the interest rate.

What to know

Shorter terms will generally save you money overall, but have higher monthly payments.

There are two reasons shorter terms can save you money:

  1. You are borrowing money and paying interest for a shorter amount of time.
  2. The interest rate is usually lower—by as much as a full percentage point.

Rates vary among lenders, especially for shorter terms. Explore rates for different loan terms so you can tell if you’re getting a good deal. Always compare official loan offers, called Loan Estimates, before making your decision.

Some lenders may offer balloon loans.

Balloon loan monthly payments are low, but you will have to pay a large lump sum when the loan is due.

Interest rate type

FIXED RATE OR ADJUSTABLE RATE

Interest rates come in two basic types: fixed and adjustable.

This choice affects:

  • Whether your interest rate can change
  • Whether your monthly principal and interest payment can change and its amount
  • How much interest you will pay over the life of the loan

Compare your interest rate options

Fixed Rate:

  • Lower risk, no surprises
  • Higher interest rates
  • Rate does not change
  • Monthly principal and interest payments stay the same
  • 2008-2014: Chosen by 85%-90% of buyers
  • Historically: Chosen by 70%-75% of buyers

Adjustable Rate:

  • Higher risk, uncertainty
  • Lower interest rate to start
  • After initial fixed period, rate can increase or decrease based on the market
  • Monthly principal and interest payments can increase or decrease over time
  • 2018-2014: Chosen by 10-15% of buyers
  • Historically: Chosen by 25-30% of buyers

What to know

Your monthly payments are more likely to be stable with a fixed-rate loan, so you might prefer this option if you value certainty about your loan costs over the long term. With a fixed-rate loan, your interest rate and monthly principal and interest payment will stay the same. Your total monthly payment can still change—for example, if your property taxes, homeowner’s insurance, or mortgage insurance might go up or down.

Adjustable-rate mortgages (ARMs) offer less predictability but may be cheaper in the short term. You may want to consider this option if, for example, you plan to move again within the initial fixed period of an ARM. In this case, future rate adjustments may not affect you. However, if you end up staying in your house longer than expected, you may end up paying a lot more. In the later years of an ARM, your interest rate changes based on the market, and your monthly principal and interest payment could go up a lot, even double.

Explore rates for different interest rate types and see for yourself how the initial interest rate on an ARM compares to the rate on a fixed-rate mortgage.

Understanding adjustable-rate mortgages (ARMs)

Most ARMs have two periods. During the first period, your interest rate is fixed and won’t change. During the second period, your rate goes up and down regularly based on market changes. Most ARMs have a 30-year loan term.

ARMs can have other structures.

Some ARMs may adjust more frequently, and there’s not a standard way that these types of loans are described. If you’re considering a nonstandard structure, make sure to carefully read the rules and ask questions about when and how your rate and payment can adjust.

Understand the fine print. 

ARMs include specific rules that dictate how your mortgage works. These rules control how your rate is calculated and how much your rate and payment can adjust. Not all lenders follow the same rules, so ask questions to make sure you understand how these rules work.

ARMs marketed to people with lower credit scores tend to be riskier for the borrower.

If you have a credit score in the mid-600s or below, you might be offered ARMs that contain risky features like higher rates, rates that adjust more frequently, pre-payment penalties, and loan balances that can increase. Consult with multiple lenders and get a quote for an FHA loan as well. Then, you can compare all your options.

Loan type

CONVENTIONAL, FHA, OR SPECIAL PROGRAMS

Mortgage loans are organized into categories based on the size of the loan and whether they are part of a government program.

This choice affects:

  • How much you will need for a down payment
  • The total cost of your loan, including interest and mortgage insurance
  • How much you can borrow, and the house price range you can consider

Choosing the right loan type

Each loan type is designed for different situations. Sometimes, only one loan type will fit your situation. If multiple options fit your situation, try out scenarios and ask lenders to provide several quotes so you can see which type offers the best deal overall.

Conventional

  • Majority of loans
  • Typically cost less than FHA loans but can be harder to get

FHA

  • Low down payment
  • Available to those with lower credit scores

Special programs

  • VA: For veterans, servicemembers, or surviving spouses
  • USDA: For low- to middle-income borrowers in rural areas
  • Local: For low- to middle-income borrowers, first-time homebuyers, or public service employees

Loans are subject to basic government regulation. 

Generally, your lender must document and verify your income, employment, assets, debts, and credit history to determine whether you can afford to repay the loan.

Ask lenders if the loan they are offering you meets the government’s Qualified Mortgage standard. 

Qualified Mortgages are those that are safest for you, the borrower.

Mortgage insurance: what you need to know

Mortgage insurance helps you get a loan you wouldn’t otherwise be able to.

If you can’t afford a 20 percent down payment, you will likely have to pay for mortgage insurance. You may choose to get a conventional loan with private mortgage insurance (PMI), or an FHA, VA, or USDA loan.

Mortgage insurance usually adds to your costs.

Depending on the loan type, you will pay monthly mortgage insurance premiums, an upfront mortgage insurance fee, or both.

Mortgage insurance protects the lender if you fall behind on your payments. It does not protect you.

Your credit score will suffer and you may face foreclosure if you don’t pay your mortgage on time.

Source: Consumer Financial Protection Bureau: www.consumerfinance.gov

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