What is The Best Loan For Buying A House?

Finding the best loan for buying a house can be a very difficult task. This is because as a borrower, you need to get a loan with competitive rates, favorable terms, affordable monthly payments, and a reduced down payment when necessary. You also need to take advantage of first-home buyer benefits and other government incentives when looking for the best loan for buying a home. Finding a home loan that checks all these boxes can be hard especially when you don’t know where to look.

Most lenders prefer borrowers with good credit scores, lower DTI ratios, established credit history, etc. Even if you have all these boxes checked, you still need to apply for the right loan. Your current financial situation, desired payment structure, government incentives, and down payment will affect the type of loan you qualify for.

If you want to know what loan is best for you when buying a house, this article will be your guide.

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Take advantage of government incentives and the good credit you have built

The best loan for buying a home in your case might not come with the lowest interest rate. Instead, the incentives you are getting could affect the loan you go with.

For example, if you live in a rural area, a USDA loan could be the best loan for buying a house in your situation. The same loan, however, will not be a great option for someone who is buying a condo downtown. Or if you are a veteran, a VA loan will be the best loan to buy a home compared to conventional loans. This is because VA loans might not require a down payment, interest rates are competitive, and you might not even purchase private mortgage insurance(PMI).

If you have a good credit score, a lower DTI ratio, and at least a 20% down payment, a conventional loan will be the best choice. This is because a large down payment will lower your mortgage balance. As a result, your monthly payments will be lower and the house will cost you less money due to fewer interest charges.

You will also need to choose between a fixed-rate mortgage and an adjustable-rate mortgage. The interest you pay on your loan and monthly payments do not change for the duration of the loan on fixed-rate mortgages. Adjustable-rate mortgages, on the other hand, start with a fixed interest for a few years, before your interest starts going higher or lower based on market rates.

Understand how a fixed-rate mortgage and an adjustable-rate mortgage will affect your monthly payments and finances in general

Before you sign up for any mortgage, you need to understand how different rate structures will affect your monthly payments and your finances. That is know the difference between fixed-rate and adjustable rates and what to expect from each one. Before we dive into the best loan for buying a house, let’s see how these two mortgages differ.

Fixed-rate mortgage(FRM): Good for people staying in the house for a long time and when market rates are lower

Most homeowners qualify for Fixed rate mortgages due to their low risks and great payment structures. Fixed-rate mortgages(FRM) are great for people who plan to stay in their houses for a very long time and need stability in their monthly payments. FRM will also serve you well when market rates are low by the time you buy a house. Having a fixed-rate means that the interest rate you pay and monthly payments will be the same for the duration of the mortgage.

The following are some of the pros and cons of FRMs to help you evaluate if a fixed-rate mortgage is the best loan for buying a house in your case.

Pros of getting a fixed rate mortgage when buying a house.

The interest rate will never change
Monthly payment will stay the same
Longer terms(15 year or 30 year terms)
The principal amount will go higher and interest charges go lower through the amortization process
Property tax can change as the property appreciate or depreciate
In case you locked in a lower rate, you will always pay a low rate no matter what happens in the market

Cos of fixed-rate mortgages

You will be required to pay private mortgage insurance(PMI) when your down payment is less than 20%. PMI protects the lender in case you default on the mortgage. Usually, PMI gets waived when your mortgage balance reached 78% of the home purchase price.
Having a fixed rate means that you will not benefit from low interest when market rates go lower. You can take advantage of low rates by refinancing your mortgage.
If you get FRM when market rates are really high, you will pay higher interest charges before you can qualify for refinancing.

Adjustable-Rate Mortgage(ARM). Good for short-term duelers or when rates are higher and you expect them to go lower over time

In case the interest rates are higher across the industry, a fixed rate might not be the best form of a mortgage when buying a house. This is because your interest rate will stay the same for the duration of the loan unless you refinance your home. What you can do instead, is to get an adjustable-rate mortgage(ARM) which is the alternative to a fixed-rate mortgage. Why an adjustable rate? Because your interest will change over time to reflect market rate changes. That is you pay a higher interest now and pay a lower rate when market rates decrease.

But, your interest rate can also go higher in case market rates continue to climb. For this reason, the house might cost you more money in this case.

In addition, you will not have stability in your monthly payments. As your interest rate changes, your monthly payments will also change.

Is the adjustable rate mortgage the best loan for buying a house? Check ARM highlights for more details.

Adjustable-rate mortgages start with a fixed-rate interest known as a teaser rate for 5 to 10 years. 5 years is more common. After, your rate will change to an adjustable-rate mortgage.

After this period, your interest rate on the mortgage will mimic market rates

ARMs include rate caps(Periodic Caps and/or Lifetime Caps), according to Experian. These caps limit how much your rate can rise or fall in a given period of time or during the lifetime of the mortgage. Common Caps are 2% for Periodic Caps and 5% for Lifetime Caps.

If rates go higher before the initial fixed-rate phase, refinance the mortgage or sell the house. This will prevent you from paying a higher-than-necessary interest rate or wrecking your finances.

The following are the best loans for buying buy a house.

1. Conventional loans: Offered by lenders without government incentives and they are the best loans for buying a house when you have a large down payment and a good credit score.

Conventional loans are some of the most widely used mortgages. These loans do not come with government incentives. Private lenders such as banks, credit unions, and mortgage companies offer these loans.

Since conventional loans do not have government incentives, they usually have stricter terms compared to other loans. A conventional mortgage will be the best loan to buy a house in your case if you have a good credit score, solid credit history, a lower DTI ratio, and a stable income.

The following are some of the highlights of conventional mortgages you should know if you are planning to buy a house.

They can take as low as a 3% down payment
You need to have at least a 620 credit score
Having a lower DTI ratio and a stable income helps you qualify for more money
PMI might be required for down payments under 20%

The impact of the lack of government incentives on conventional loans

Unlike FHA loans that are insured by the Federal Housing Administration(FHA), conventional loans are not. This means that conventional loans are stricter and lenders evaluate borrowers very carefully. Conventional mortgages are flexible and can take as low as 3%. But, in order to put this low down payment, your lender might require a higher credit score.

By default, you need a 620 credit score to qualify for a conventional loan.

Lenders usually require a low Debt-to-income ratio for conventional mortgages. In rare cases, your lender can take a DTI of as higher as 50%. Most lenders consider a DTI ratio of lower than 43%. To increase your approval odds, keep your ratio under 28%. Most lenders also require proof of income for the last two years prior to applying for the mortgage.

The conventional mortgage is the best loan for buying a house when you are a first home buyer or have a large down payment. For example, first-home buyers can put as low as 5-10% in a down payment. Those with higher credit scores can put down as low as 3%.

The following are some of the benefits of conventional loans

PMI cancels when equity reaches 22%.

Homebuyers with higher credit scores pay less for private mortgage insurance.

Conventional mortgages come with higher loan limits ($647,200 for 2022).

Allow a lower down payment

Conventional loans come with less strict property standards

Drawbacks of conventional mortgages

Need a higher credit score. At least 620.

Strict eligibility requirements. Mortgage companies, banks, and credit unions choose less risky borrowers due to the lack of government incentives.

A lower DTI ratio is needed. Borrowers with too many debts find it harder to qualify for conventional loans.

Need to purchase a PMI when your down payment is under 20%. PMI protects the lender when you default on your mortgage.

You pay higher closing costs when your down payment is lower

2. FHA loans

If you are looking for the best loan to buy a house, consider an FHA loan. FHA loans are some of the most flexible loans on the market. They require low down payments(at least 3.5%) which waive the 20% down payment requirements for conventional loans. In addition, FHA loans do not require the good credit scores needed for conventional mortgages.

Keep in mind that being the best loan for buying a house in terms of down payment, they also come with drawbacks. Homeowners pay higher closing costs due to borrowing more money. In addition, higher mortgage balances increase your monthly payments to cover interest and principal. As a result, the house cost you more money.

Evaluate the benefits and drawbacks of FHA loans to see if this is the best loan to buy a house.

Benefits of FHA loans

There are many reasons an FHA loan might be the best loan for buying a house. For example, if you have bad credit, have negative items on your credit reports, don’t have the required down payment for conventional loans, or have a higher DTI ratio, an FHA loan will be a good choice. The following are some of the benefits of FHA loans that make them stand out for many homebuyers.

Requires lower credit score. Unlike conventional loans where your credit score must be at least 620, many FHA loans require a credit score of 580.

No income limits. There are no high or low-income limits for FHA loans. This means that if you have cash and want to use it for other projects, you can save your cash and still buy a house by putting down as low as 3.5%.

Flexible for people with bankruptcy, foreclosure, and chapter 13 discharge on their records. Most lenders will deny you a mortgage and other forms of credit when you have these negative items on your credit reports. For example, a bankruptcy will stay on your credit reports for 10 years. During this period, many lenders will not consider your credit account applications. For an FHA loan, you might be approved for a loan 2 years after filing for bankruptcy or after a foreclosure. Learn how to avoid foreclosure on your home in case you are struggling to make payments.

FHA loans accept higher debt-to-income(DTI) ratios. Most lenders prefer borrowers with DTI ratios under 28% for conventional and personal loans. FHA loans, however, can take as high as 50% or more. If you have more debts and think you cannot qualify for other loans, apply for FHA loans.

FHA loans require a lower down payment. In case you don’t have a large down payment, an FHA loan could the best loan for buying your dream home. This is because These loans require a much lower down payment compared to conventional loans.

Your down payment usually depends on your credit score. Having a credit score of 580 is important to qualify for a 3.5% down payment. People with a credit score under 580 may still qualify for a 10% down payment. The higher your credit score, the more your lender is willing to take a lower down payment on the loan.

The downside of FHA loans

A low down payment results in higher closing costs. A small down payment such as 3.5% results in borrowing more money. By borrowing more money, you automatically pay higher closing costs since some of your closing costs are expressed as a percentage of the loan amount.

Putting less than 20% down payment results in purchasing the Mortgage Insurance Premium(MIP). With the FHA loan insurance, you will have two different payments. The first one will be the upfront payment which is 1.75% of the total cost of the loan. The upfront payment will be due at the closing date. The second payment will be an additional yearly payment. This payment will depend on your down payment, mortgage term length, and loan-to-value ratio(LTV). This annual MIP charge can usually range between 0.8% to 1.05% of the loan value. You cannot cancel the MIP unless you refinance your mortgage. But, if you have at least a 10% down payment, the MIP will last only 11 years.

The house will cost you more money. Having longer-term or borrowing more money due to low down payments means that the interest charges will be higher. As a result, your monthly payments will be higher and the house will cost you more money.

Some sellers might refuse your offer when using FHA loans. Some sellers find conventional loans more attractive than FHA loans. In case you think the FHA loan is the best loan to buy a house, find a seller who doesn’t restrict the type of loans you use.

The loan imposes property standards. Before you close on the property, an appraiser will inspect the property and make conclusions as to whether it meets the standards or not.

There is a limit to how much you can borrow. For 2022, you can borrow up to $420,680 in the lower-cost area and $970,800 in expensive markets.

You have to live in the house as your primary residence

3. VA loans

VA loans or Veterans Affairs loans are loans provided to servicemembers, veterans, and qualified spouses to buy and own homes. If you belong to this category of borrowers VA loans might be the best loans to buy a house. What makes VA loans beneficial for qualified borrowers is that they do not require any down payment and you will secure a much lower interest rate due to the government incentives.

In addition, your private mortgage insurance is not required and your closing costs will be limited. Other factors that affect your loan approval rates such as credit scores do not play a major impact in getting a VA loan.

Keep in mind that your lender might require a down payment when you are using a VA Home Loan Guaranty. The VA Home Loan Guaranty means that you get the loan from a bank, credit union, and other approved lenders. Then, the VA works with your lender to guarantee your loan and pays the lender in case you default on your loan.

4. USDA loans

The U.S. Department of Agriculture helps rural families become homeowners. The USDA achieves this goal by offering loans to qualified rural families through USD loans. Just like any other government-backed loans, USDA loans are backed by the USDA and it helps lenders to offer competitive rates to homebuyers. One of the benefits of USDSA loans is that a down payment is not required.

There are three types of USDA loans.

USDA loans Guarantees. Lenders who participate in USDA loan programs provide these loans at low down payments.

USDA Home improvement loans. These loans offer qualified homeowners the flexibility to make home improvements.

USDA Direct loans. These loans offer low-interest rates to qualified low-income families

Eligibility requirements for USDA loans

Just like any other loan, the USDA has its own eligibility requirements for its loans. Below are some of these requirements. If you are looking for the best loan to buy a house, check the following eligibility and see if you qualify for USDA loans.

You must be in an eligible rural area. So, before you buy your home or apply for a USDA loan, make sure that its location is in USDA designated location.

Borrowers must be US citizens or permanent residents, or noncitizen nationals.

Have a good credit score. Many lenders prefer a credit score of 640 or higher for USDA loans.

You must also have a lower DTI ratio. Most lenders recommend a DTI ratio of under 43%. Your DTI ratio is the ratio of your current monthly debt payment to your monthly gross income multiplied by 100. The lower your ratio the better. A higher ratio indicates that you have too much debt already, and therefore, you cannot afford to take on more debt.

Your income must be within acceptable limits. USDA is designed to help rural families in financial need. To qualify for USDA loans, your adjusted gross income must be lower than 115% of the median income in the area.

Again, USDA loans are good for someone who does not have enough down payment and want to buy a house in a designated rural area. These loans also come in handy because you might be eligible to put your closing costs in monthly payments rather than paying them off upfront. Those with bad credit might also qualify for USDA loans.

5. Non-conforming loans

There are times when your financial conditions do not allow you to get conventional loans. That is you do not qualify for VA loans, Fixed-rate or Variable rate loans, USDA loans, etc. When you find yourself in this category of borrowers, things can get a little harder. But, do not give up yet.

There are other loans you can apply for and they are known as non-conforming loans. In other words, these are loans for people who do not meet funding qualifications due to the lack of down payment, credit requirements, higher loan amount, lack of collateral, etc. You might also need to get a non-conforming loan because what you are intending to do with the loan amount does not align with normal mortgage terms.

Most home loans are supported by Fannie Mae and Freddie Mack which are government institutions. In case your falls outside their criteria, you might need to get funding elsewhere or come up with a difference. You will still get non-conforming loans from private institutions such as banks, mortgage companies, and credit unions. However, the terms that govern these loans will be different from government-backed loans and convention loans.

The bottom line

Getting the best loan for buying a house is crucial to you as a homeowner. A good loan will come with competitive rates, affordable down payment, and monthly payments, with fewer restrictions.

If you are in the market shopping for a mortgage, first consider if you need a fixed-rate or adjustable-rate mortgage. Then evaluate the category of borrower you are in. For example, if you are a Veteran, A VA loan might be the best loan for buying a house in your case.

But, if you have the required down payment, a good credit score, and a lower DTI ratio, a conventional mortgage will be the best loan for your home purchase.

The process of choosing the best loan will depend on your current financial situation, the government incentives you qualify for, and the payment structures you desire.