Mortgages remain the largest form of consumer debt, representing 68% of all debt in the U.S.
With a $60 billion increase from the first quarter of 2018, the current mortgage debt amounts to $10.2 trillion.
Mortgage originations, which include refinanced mortgages, account for $437 billion of that debt.
You may be a first-time home buyer in search of the best home loan. Or perhaps you’re a current homeowner looking for a way to reduce your monthly payments or tap into your home’s equity for access to quick cash.
Either way, it’s important to know what you’re getting yourself into before making a decision.
Home purchase mortgages
The “American dream” is made up of many parts—homeownership is at the top of that list. But most people can’t afford to make that dream a reality without some help.
While there are many home loans available, the most common mortgage types include:
- Fixed-rate home loans.
- Adjustable-rate home loans.
Fixed-rate home loans
With a fixed-rate mortgage, your interest rate and monthly payment will stay the same throughout the life of the loan. Changes in the market will not impact your loan.
Most fixed-rate loans generally have a repayment term of 30 years. However, you can choose a 10-, 15-, or 20-year term as well.
Some borrowers might even be able to get a 40- or 50-year term depending on their financial situation and the lender.
Adjustable-rate home loan (ARM)
Unlike a fixed-rate loan, your payment amount will vary each month. That’s because the interest on an adjustable-rate mortgage fluctuates with the market.
So your monthly payments may increase or decrease from month to month.
There’s a cap on how much your rate can change at any one time (up or down) as well as a lifetime cap limiting how high your interest can go.
FHA loans are insured by the Federal Housing Administration and account for about 20% of home loans in the U.S. They often have looser eligibility requirements as well as lower down payments and closing costs.
The FHA doesn’t directly offer these loans. Rather, they provide mortgage insurance to their lenders. That way, the lender will be reimbursed if a borrower defaults on their loan.
So you’ll have to pay a one-time, upfront mortgage insurance premium (MIP) equal to 1.75% of the loan amount. You’ll also have to pay an annual MIP, ranging from 0.45% to 1.05%, which is included in your monthly payments.
Backed by the Department of Veteran Affairs, VA home loans are available to veterans and active-duty military members. VA loans are issued by private lenders.
They offer lower interest rates and don’t require a down payment. And, unlike an FHA loan, you don’t have to pay for private mortgage insurance.
But there is a funding fee, typically between 1.5% and 3.3% of the loan amount, which you’ll have to pay upfront.
USDA home loans
If you’re buying a home in a rural area, you might want to consider a USDA loan offered by the U.S. Department of Agriculture. With 100% financing, low interest rates, and low fees, these loans are designed for homeowners with a tight budget.
Refinancing your mortgage is the process of replacing your current home loan with a new one.
The purpose is to lock in a lower monthly payment by getting a new loan with a lower interest rate and better term.
Homeowners refinance their mortgage for reasons such as:
- Getting a lower interest rate and monthly payment.
- Changing an adjustable-rate loan to a fixed-rate loan.
- Consolidating debt.
- Removing someone from the original loan.
Here is a list of the benefits and the drawbacks of mortgage refinancing.
- Lower interest rate. A lower rate can result in paying less interest every month and over the life of the loan.
- Shorter loan term. You can pay off your loan sooner by shortening the term on your loan.
- Extended loan term. On the flip side, you can extend your loan term to get a lower monthly payment.
- Interest rate type. If you want predictable monthly payments, for example, you can refinance an adjustable-rate loan into a fixed-rate loan.
- Get cash back. You may be able to get cash back by refinancing if you have enough equity in your home.
- More interest. Refinancing with a higher rate can cause you to pay more interest every month and over the life of the loan. The same is true if you refinance to a longer term—your payments may be lower, but the amount of interest you pay might be higher in the long run.
- Potentially higher payment. You might get a lower rate when you refinance to a shorter term, but your payment might be higher.
- Costs and fees. Closing costs could be thousands of dollars that you’ll likely have to pay out-of-pocket. And you might not recover these costs if you plan on selling your home within the next few years.
Borrowing against your home equity
Home equity loans
A home equity loan (HEL) allows you to use your home’s equity to borrow a fixed amount of money, which you’ll receive as a lump sum upfront.
With a low fixed interest rate, these loans generally come with a 15- or 30-year repayment term.
You’ll have to repay your loan in addition to your normal mortgage payment. So, make sure you’ll be able to afford both payments before committing.
Home equity lines of credit
A home equity line of credit (HELOC) is similar to a credit card, enabling you to borrow money when you need it. Your home is used as collateral to secure the loan.
Like a credit card, you can borrow up to your credit limit, pay it back, and then borrow again—rinse and repeat. Your credit line is based on a percentage of your home’s equity.
HELOC’s come with low interest rates (which are typically variable) and the interest you pay is tax-deductible.
Unlike a home equity loan, you can draw from your HELOC whenever you’d like. You’ll usually only pay interest on the money you draw for a set period. The draw period on a HELOC is typically 10 years.
You can no longer withdraw money from your line of credit once the draw period ends. So, you’ll either have to repay the debt in full or your monthly payments will increase to pay off the loan principal.
To help alleviate the potentially high costs at the end of your draw period, some lenders will allow a longer repayment period or require you to repay some of the principal during your draw period.
Compare the pros and cons of HELOCs to make a better decision.
- Easy access to cash if you own a home and have equity.
- A lower rate than a credit card, auto, student, or personal loan, or other unsecured debt.
- Flexible: borrow only what you need.
- Even consumers with not-so-great credit can qualify.
- Interest may be tax-deductible.
- You could lose your home if you don’t make payments when required.
- A variable rate that can fluctuate with the market.
- You might be tempted to borrow more than you should.
With a reverse mortgage, you can convert part of your home’s equity into cash. You must be at least 62 years old to qualify. Many borrowers use to loan to help pay for living expenses in retirement.
The three types of reverse mortgages include:
- Single-purpose reverse mortgages (property tax deferral programs)
- Proprietary reverse mortgages (jumbo reverse mortgages)
- Home Equity Conversion Mortgages (HECMs)
Compare the pros and cons of reverse mortgages to make a better decision.
- Borrowers do not make monthly repayments.
- No income needed to qualify.
- Access home equity without selling home.
- Can be used to pay off small mortgage balances.
- Eligibility relies on home equity.
- Maintain ownership of your home.
- Flexible payment options.
- Reduces inheritance for your heirs.
- High costs (especially with MIP).
- Borrower(s) must live in the house as their primary residence (can’t be away more than 12 months).
- Borrower(s) must pay ongoing maintenance costs, property tax, insurance payments, etc.
- Interest accrues on the loan every month.
- No annual tax deduction for interest.
- Not available to those under 62 (in most cases).
- The loan is secured by your home so defaulting could result in foreclosure.
Learn more about the three types of reverse mortgages.
You can receive the cash as a lump sum, a line of credit, or in monthly payments. The amount will grow over time as interest is added to the loan each month.
You won’t have to make payments on the loan while you’re living in the house. You will, however, need to pay property taxes, home insurance, utilities, maintenance, and other similar costs.
Payments will start once you sell your home, stop living in it for at least 12 months, or pass away. You can pay back the loan by selling the house, using cash, or refinancing your mortgage.
Finding the right mortgage starts with doing the right research. Compare today’s leading mortgage lenders side-by-side to find the best one for you.
Andrew is the managing editor for SuperMoney and a certified personal finance counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.