Shopping for a mortgage means making two decisions that are easy to confuse. The first is what kind of loan you want — how long it lasts and whether the rate can move. The second is who you borrow from. This article covers the first. Once you know which loan type fits, comparing lenders becomes a much simpler exercise.
Start With the Payment, Not the Price
There are two sensible ways into this. You can start from the monthly payment you can comfortably carry and work backwards to a loan amount, or you can start from a target home price and see what the payment looks like. The first is the safer habit, because a lender will often approve you for more than you want to spend.
Whichever way you start, remember that the loan payment is not the housing payment. Property taxes, homeowners insurance and, if your down payment is under 20 percent, mortgage insurance all ride along with it. We break that down in what is actually in your mortgage payment.
Fixed-Rate Mortgages
The interest rate is set at closing and never changes. Your principal-and-interest payment is identical in year one and year 30. That predictability is the whole product, and it is why fixed-rate loans dominate the market.
The trade-off is that a fixed rate cuts both ways. If market rates fall well below yours, your payment does not follow — you have to refinance to capture the drop, and refinancing has its own closing costs. Fixed-rate loans also usually start at a higher rate than an adjustable loan of the same term.
See what is a fixed-rate mortgage for a fuller explanation.
Adjustable-Rate Mortgages
An adjustable-rate mortgage, or ARM, starts at a lower rate that is fixed for an introductory period, then adjusts on a schedule against a published index. Most ARMs sold today are hybrids described by two numbers — a 5/6 ARM is fixed for five years, then adjusts every six months.
The features that matter are the caps: how much the rate can move at the first adjustment, how much at each one after that, and how high it can go over the life of the loan. Read those three numbers before anything else, because they define your worst case. An ARM is a reasonable choice if you are confident you will sell or refinance before the fixed period ends, and a gamble if you are not.
Our full comparison is at ARMs vs fixed-rate mortgages.
How Long Should the Loan Run?
Thirty years is the default. Fifteen years is the main alternative, and the difference is stark: a shorter term carries a higher monthly payment but a lower rate, and it costs dramatically less in total interest because you are borrowing for half as long.
A useful middle path is to take the 30-year loan for the flexibility of the lower required payment, then pay extra toward principal when you can. You capture most of the interest saving without committing to the higher payment in a month when your car needs a transmission.
Government-Backed Loan Programs
- FHA loans — insured by the Federal Housing Administration, with lower credit and down-payment requirements. The trade-off is a mortgage insurance premium that, on most current FHA loans, lasts the life of the loan unless you refinance out.
- VA loans — for eligible service members, veterans and some surviving spouses. Often no down payment and no monthly mortgage insurance, with a one-time funding fee instead.
- USDA loans — for buyers in eligible rural and some suburban areas, with income limits.
- Conventional loans — not government-insured. These are the loans that follow Fannie Mae and Freddie Mac guidelines, and the ones where private mortgage insurance can be cancelled once you build enough equity.
Products You May Read About but Probably Should Not Take
Older guides to mortgage shopping give a lot of space to balloon mortgages, interest-only loans and “two step” products such as 5/25s and 7/23s, where a low payment for several years is followed by a large lump sum or a sharp reset. Most of these largely disappeared from the owner-occupied market after the 2008 housing crisis, when ability-to-repay and Qualified Mortgage rules required lenders to verify that a borrower could actually afford the loan.
You may still encounter them in seller financing or commercial deals. If a loan offers a payment that looks too comfortable, find the sentence that explains what happens when the introductory period ends — that sentence is the product.
Comparing Offers Honestly
The advertised interest rate is not the cost of the loan. The annual percentage rate, or APR, folds in points and most lender fees, which is why it is usually a little higher than the rate. Two loans with the same rate and different APRs are not the same loan.
Comparing APRs is only fair across the same loan type and term. A 5/6 ARM’s APR assumes things about future rates that a 30-year fixed does not, so use APR to compare like with like, and use the caps and the term to compare across types. Then read how to choose a mortgage lender for the mechanics of putting several offers side by side.