Buying a House in 2008: What Type of Loan Should I Get?

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For those of you just joining the “Buying a House in 2008″ series, I have recently been going through the process of purchasing a house for my wife, daughter and myself. It is our first house so instead of hoarding all of our newly acquired knowledge it made sense to share the lessons I have learned with the readers of Schaefer’s Blog, many of whom I know are getting ready to purchase their first homes soon as well.

The point of Schaefer’s Blog is to share lessons in skilled living. Since buying a house is the single largest purchase most of us will ever make, knowing how to do it well is a great skill to have. A couple weeks ago I wrote about what I had learned in determining how much of a house you can afford. Today, I present a quick and dirty guide to the most common types of home loans and the pros and cons of each.

A home loan, also called “mortgage” is simply the money you get from a bank or lender to bridge the gap between the amount of money you can pay for the house and the amount the house actually costs. There are endless types of mortgages from the basic to exotic. Much of the current mortgage crisis has to do with people choosing unusual home loans that they didn’t really understand or couldn’t afford. The loans I cover are the basics, by no means a comprehensive guide, but a good starting place for those looking to finance a home purchase.

VA Loan - I throw this in because I’m in the military as are many of my friends. The VA (Veteran’s Affairs) loan is designed for qualified veterans, reservists and active-duty members and their eligible spouses. Many lenders like USAA make this option available and the benefits can be quite helpful. Here’s the official site.

Pros: No down payment needed to qualify and no mortgage insurance premiums. Also, the government limits the closing costs and origination fees lenders can charge.

Cons: VA loans have a funding fee, typically around 2% (can be lower if borrower puts 5% down). The maximum amount guaranteed by a VA loan is $240,000. While this is enough for many, in more expensive parts of the country it may not be enough.

Who Should Consider It: Any military member or spouse that qualifies who does not have money to put down on a house, or wants to use that money elsewhere and will be able to purchase their home without going over the $240,000 maximum.

Fixed Rate - A fixed rate mortgage is one in which the interest rate and monthly payments stay the same for the entire term of the loan. The most common terms are 30 years and 15 years, but many others also exist.

Pros: You never have to worry about your interest rate going up unexpectedly or your monthly payment changing in any way. No matter what the markets are doing your rate is locked in so you have peace of mind.

Cons: Peace of mind has a price. Interest rates on fixed rate mortgages are generally higher than the initial rates on an adjustable rate mortgage. Plus, if interest rates happen to go down significantly after locking in your rate you will lose money, either in opportunity costs or in paying the fees associated with refinancing your mortgage to get a lower interest rate.

Who Should Consider It: Anyone who like stability and is looking at living in their home for a longer period of time like 10 years or more.

Adjustable Rate (ARM) - An adjustable rate mortgage is one where the interest rate is initially fixed for a set term and is then allowed to float (follow the market rate) after the initial term is up. Every ARM has an adjustment margin which is the amount the lender adds to whatever index they follow for the market rate, so the market rate plus the margin is actually what you will end up paying in interest after the initial fixed term is up.

Pros: Lower initial monthly payments than a fixed rate mortgage.

Cons: Once the initial fixed term is up you must either refinance or risk paying higher payments if interest rates go up, both costing more money.

Who Should Consider It: Someone that plans on reselling their home within a short time after purchase. For example, if you are in the military and know that you’ll move every four years, a 5/1 ARM may make sense. The “5″ is the number of years the mortgage is fixed initially and the “1″ is the adjustment interval thereafter. A 5/1 would give you a lower monthly payment than that of a fixed rate.

Resources:
Mortgage New & Advice - Bankrate.com
Pick the Right Mortgage - Kiplinger.com
Mortgages - USAA.com
Which Mortgage is Right for You? - Interest.com
…and before you get too excited about the possibility of making loads of money off real estate check out my man Ramit Sethi’s posts on real estate…I’m not saying don’t buy a house, just don’t be stupid.

Related posts:

1. Buying a House in 2008: How Much Can You Afford?
2. 2008: The Year to Buy a House?
3. Real Estate Alphabet Soup
4. 7 Common First-Time Home Buyer Mistakes