How to Choose the Right Mortgage for You
Even if you’ve been watching home-buying shows since elementary school, you probably were too busy pondering kitchen design to think much about the practical side of what’s likely to be the biggest purchase you’ll ever make. But now that the time has come, there are more pertinent questions to consider when buying a home, such as, “How much house can I afford?” and, “What type of mortgage should I get?” Choosing a mortgage is a major decision — one you’ll be reminded of each month when the payment comes due. Fortunately, plenty of resources are available to help you evaluate which type of mortgage is right for you.
From banks to credit union mortgages and everything in between, we discuss ways to personalize the process, so when the question, "How much home can I afford?" pops into your head as you scroll through online listings, you'll know the answer. Learn to determine how much you can borrow, your mortgage down payment and mortgage payment options, and what to look for when comparing interest rates on home loans.
We know the decision process on what type of mortgage to get can be a lot to take in. So, after you read on for the basics, reach out to your local credit union mortgage specialists, who are happy to fill in any gaps. They may even have some hot tips on that dream kitchen layout.
Determine How Much House You Can Afford: 3 Steps
As you figure out how to save for a house, it helps to know that there's no one-size-fits-all mortgage solution. The right mortgage for you is affordable and customized to your unique needs — whether that means a low down payment, an adjustable
interest rate, or a 30-year loan.
For example, you may find you have a five-bedroom taste, but a three-bedroom budget. Follow these steps to get a better idea of how much home you can afford so you can update your search parameters accordingly.
Step 1: Assess your situation
How much house you can afford depends on a variety of factors. The amount you can borrow for a home loan will depend on factors such as:
- Interest rates. Think of interest rates as the cost of your loan. When interest rates are higher, your cost goes up because your interest rate is added to each monthly payment.
- Household income. The median household income in the U.S. is just under $65,000. If your household income is higher than the median, you may be able to afford a more expensive mortgage.
- Credit scores. Credit scores are based on the information in a person’s credit report. Generally, the higher the credit score, the more likely it will be that you qualify for a home loan and get a better mortgage loan rate.
A word of advice – some first-time homeowners forget to factor in the additional costs of a mortgage loan and then get sticker shock when they sit down with a lender. These costs can include property taxes, homeowners insurance, homeowners association (HOA) fees, and any additional recurring costs. (Read all fine print closely!) Even if your dream home falls into the typical price range for houses in the U.S., a seemingly affordable home may be out of reach once taxes and fees are included in your monthly mortgage payment.
Generally, financial institutions want to see a debt-to-income (DTI) ratio of 36% or lower to approve you for a loan. This means that all your debt, including the monthly mortgage payment, shouldn't total more than 36% of your gross household income. However, community-based, not-for-profit credit unions tend to have more flexible standards and are far more likely to consider the member's complete financial picture in determining financing solutions than big banks.
For example, suppose you expect your income to increase significantly over the next few years. In that case, a credit union may have loan products that can accommodate a higher DTI ratio and allow you to buy a home now.
Step 2: Decide on your down payment
A down payment is a lump sum you pay toward purchasing a house. The higher the down payment, the lower your monthly mortgage payment. The average first-time home buyer puts down about 7% of the purchase price, while repeat buyers’ average down payment is closer to 17%, according to the National Association of Realtors.
So, if you are a first-time buyer putting down 7% on a $200,000 home, you would pay $14,000 and take out a home loan for the remaining $186,000. Putting down 17% would result in a $34,000 down payment with a home loan of $166,000.
Many loan options allow for a smaller down payment in exchange for private mortgage insurance (PMI) or a slightly higher interest rate. If you've had trouble saving for a home, choosing a loan that requires a lower down payment can help. Speak with your local credit union mortgage expert for more details on this level of flexibility.
Step 3: Consider your future plans
Remember that mortgage loans and home loans are designed as long-term propositions. Nearly 90% of homeowners choose a 30-year fixed-rate mortgage. Beyond, “What type of mortgage should I get?” ask yourself these questions:
- Are you hoping to purchase your forever home?
- Do you plan to move in the next few years?
- Will you be expanding your family?
Questions like these can help you decide which loan type makes the most sense for your circumstances. For example, if you're planning to move soon, locking in a low-interest 30-year loan may not benefit you as much as taking out an adjustable-rate mortgage with a "teaser" rate. But on the other hand, if you have no plans to relocate, a conventional fixed-rate 30-year loan eliminates the possibility of future rate hikes.
What type of mortgage should you get?Mortgages involve multiple components that make them highly customizable and allow you to pick the options and features that best fit your needs. Consider these elements:
- Term length. As mentioned above, the most common term length for a mortgage is 30 years, followed by 15 years. Some financial institutions will work with you to create a customized term length, such as 10 or 20 years. The longer your mortgage term, the more interest you will pay. However, the monthly payment for longer-term loans will be smaller.
- Interest rate. The interest rate is calculated as a percentage of the original loan amount, known as the principal sum. It is the money you, the borrower, pay to the lender each payment period. There are two primary interest rate types:
- Fixed interest rate. A fixed interest rate is a set percentage that does not change throughout the loan unless you choose to refinance.
- Variable interest rate. A variable interest rate, often referred to as an adjustable-rate mortgage (ARM), changes over time.
- Type of loan. There are many different types of home loans. Some are government-backed or cater to first-time homebuyers. Others are intended for investment properties or planned short-term purchases.
The best way to learn about your specific loan options is to get estimates from a variety of lenders. Lenders compete for borrowers' business, so it's often a good idea to get several loan estimates to ensure you're getting the best deal that works for your needs.
When you are collecting estimates, make sure to include your local credit union. Because credit unions are community-based not-for-profits, they can often offer more competitive rates than banks that answer to investors and shareholders.
Glossary of Important Mortgage Loan Terms
To make a solid comparison, it's important to understand all the associated payments and fees. Here are some of the key terms you will encounter:
- Term: The time length of the loan.
- Interest rate: The price you'll pay per payment period to the lender for the service of borrowing money. There are two types of mortgage interest rates:
- Fixed-rate mortgages have a single interest rate that never changes.
- Adjustable-rate mortgages (ARMs), or variable rate mortgage loans, have an interest rate that adjusts up or down at specified periods (every six months, yearly, or longer) based on the prime rate.
- Annual percentage rate (APR): The yearly cost of a loan expressed as an annual percentage. Your APR will be higher than your interest rate, as it includes the cost of fees and other expenses associated with the mortgage.
- Closing costs: Expenses paid when you sign purchase papers and ownership of the house transfers to you. Closing costs usually include things like title insurance, appraisal and inspection fees, and prepaid property taxes or insurance premiums.
Additional Resources for Choosing the Right Mortgage
When deciding what type of mortgage to get, it’s helpful to seek information from multiple resources. Check out these websites for handy suggestions and do-it-yourself calculators that can aid in the decision-making process:
- InCharge.org: Learn how to calculate your debt-to-income ratio.
- ConsumerFinance.gov: Helpful tips on how to get the best interest rates.
- Hud.gov: The official U.S. Department of Housing and Urban Development website is full of resources on everything from knowing your rights as a buyer to best practices when making an offer on a home.
Choose Your Home Loan
Once you've investigated your options and assessed how each loan type would fit your needs and lifestyle, you're ready to choose your loan. A credit union mortgage can be a great option for first-time homebuyers and experienced real estate purchasers.
Credit unions have unique and flexible loan products not available at other financial institutions. Use our Credit Union Locator Tool to find a credit union near you and discover all a credit union mortgage has to offer.