How to Compare Loan Options as a Military Home Buyer
Buying a home is the largest investment that many people will ever make. It can also be an incredibly difficult decision, as there are so many options to choose from. As a military homebuyer, you may have access to a VA loan, but that’s not always the best option. And did you know that there are even multiple types of VA loans?
Even if you choose a conventional or another form of government-backed loan, like the FHA or USDA loans, there are differences in term lengths, rates, types of lenders , and even mortgage points—also called discount points—that can be purchased to reduce your monthly mortgage payments and interest rates.
To help cut through the confusion so that you can make an informed decision in your military home-buying process, we’ve put together this guide to help you better understand how to compare different home loans by looking at rates, points, loans, and lengths of the mortgage.
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To understand the difference between types of home loans, it’s important first to know what the terms mean that differentiate one loan from another. Let’s go through the most important ones:
Rate vs. APR
Some home buyers put all of their focus on the rate when looking at potential mortgage options, but your focus should instead be on the Annual Percentage Rate (APR). The rate is simply the interest that the mortgage lender plans to charge you, but the APR is that rate plus all other costs of the mortgage— meaning it’s what you will actually end up paying.
If you invest in the stock market or bonds, hearing the term “points” regarding your mortgage can be pretty confusing. In bonds, a point is equal to a 1% change in face value. In stocks, one point equals $1, and 1 basis point (bps) equals 1/100th of a percent. In banking, points often refer to the difference between the interest rate for a loan vs. the prime interest rate at the time. What you pay will be the prime rate + points above that rate.
In mortgages specifically, a point can also indicate the size of the origination fee that a lender is charging, with 1 point being equal to 1% of the loan. For instance, a $100,000 loan with a 2-point origination fee would have a $2,000 origination fee. Conversely, discount points can be prepaid to reduce the amount of interest owed overall on a mortgage.
Adjustable vs. Fixed Rate
The decision on what type of rate-based mortgage you choose could turn out to be one of the most consequential that you make. A fixed-rate mortgage follows the same interest rate throughout the life of the loan, no matter what happens with the prime rate or market. This can be bad if rates drop, but you may have the chance to refinance if that happens. There are specific VA loans that may be utilized to refinance conventional into VA Loans.
An Adjustable Rate Mortgage (ARM) changes rates according to the market and other variables. While these often sound great upfront and may start with lower costs and payments, ARMs led to a large number of foreclosures during the 2008 housing crisis. People often found themselves buying into mortgages that they could afford with the rates at which they entered the loans but were quickly caught underwater as rates increased.
An ARM will have its interest rate set against a benchmark plus an additional spread (called an “ARM margin”) and have a specified amount of time before that rate is scheduled to change (called the “fixed period). Once that fixed period ends, an ARM will transition into an “adjusted period” (also called a “floating period”) during which the interest rate can change monthly or annually.
When you see the numbers that accompany an ARM, such as a 5/1 or 2/28, those numbers are referencing the “fixed” and “adjusted” periods of the proposed mortgage. The fixed number is listed first, with the adjusted coming second. As an example, a 5/1 arm will have a 5-year fixed period and then an adjustment every year.
ARMs frequently have an interest rate cap, meaning the maximum amount of interest that could be charged. Along with traditionally lower fees and costs to start, these can be a good option if you only plan to keep the mortgage for a limited period of time.
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The traditional and most often used length of a home mortgage is 30 years, but that is far from the only option. Mortgages offer the opportunity to finance the price of a home over a period of time to make it more affordable, but the longer the loan is stretched out, the more interest you end up paying in the long run. Some financial pundits like Dave Ramsey counsel people to keep those costs low, and the 15-year loan can be a great option if you can afford it.
On the other side of the coin, a fairly new occurrence in real estate is the ability to convert your mortgage to a 40-year loan if your situation has changed and you can’t keep up with your current payments. You can’t originate a mortgage with a 40-year term, but an FHA loan may be modified to that length if you are having difficulties paying.
In general, mortgages can typically be anywhere from 8 to 30 years in length, and many of them allow early payoff through balloon payments if you have the wherewithal and desire to do so.
Types of Mortgages
As if there weren’t enough terms to know the definitions of and differences between, there are also several different types of loans that can be utilized, depending on what you qualify for. They can be broken down into three main categories: conventional, government-insured, and jumbo (non-conforming) loans.
Offered by nearly every type of mortgage lender and are called conventional because they follow the rules set out by Fannie Mae and Freddie Mac. These loans will often be started by a mortgage lender and then sold to one of those two institutions on the secondary market, which is why lenders love them so much (it takes the lender’s risk away).
Offer the lender a form of risk mitigation by providing a guarantee on some or all of the loan if the borrower should default. These types of loans can be provided by either the Fair Housing Administration (FHA), the US Department of Agriculture (USDA), or the US Department of Veterans Affairs (VA).
There are usually lower requirements for borrowers who qualify for government-insured loans, but the costs and fees may be higher. For a detailed explanation of conventional vs. VA loans, you can read our post that goes into greater detail on the differences here.
Jumbo (or Non-Conforming Loans)
These are higher than allowed based on conventional or government standards. The limits for conforming loans in 2023 are between $726,200 in most parts of the country and $1,089,300 in the more expensive areas. Jumbo loans can have higher fees, and require more documentation than other types of loans, but may be necessary if you live in an area with higher-than-average real estate values.
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Examples of What Different Loans May Cost
If you haven’t gone cross-eyed from all of the different definitions and terms yet, we can now begin to look into some examples of what different types of loans may actually cost. But before we do, there is one more thing to outline: factors that will affect (almost) any type of home loan.
For nearly all types of mortgages, lenders will use the following factors to determine how much of a home loan you qualify for, and what terms they will offer you:
- Your credit score
- The location of the property
- How much of a down payment you can pay (although some mortgages don’t require any)
- What type of loan they are offering
- The term of the loan (length)
- The type of interest for the loan (fixed rate vs. ARM)
- The loan amount and closing costs
- The total cost of the property
- Your debt-to-income ratio
There is no way to map out a hypothetical mortgage that will fit every scenario because there are so many variables involved in the total calculation. To try to come as close as possible, we will use home prices between $350,000 and $650,000, with a 13% down payment (which was the median average in 2022).
30-Year Fixed Rate
To help you better understand how some of the variables explained in this post will change how much a mortgage will cost you, let’s begin by showing the differences between fixed-rate mortgages if we only change the term length and type of loan considered.
For a $450,000 loan with a credit score between 720-739 and a 13% down payment ($58,500), you may find the following hypothetical offers from lenders for a 30-year mortgage:
- FHA Loan: 5% rate, 5.997% APR, $15,544 in upfront costs, and a $2,363 monthly payment.
- VA Loan: 5.125% rate, 5.425% APR, $12,917 in upfront costs, and a $2,132 monthly payment.
- Conventional: 5.750% rate, 6.244% APR, $9,326 in upfront costs, and a $2,448 monthly payment.
*Note that the conventional loan has lower upfront costs, but a higher monthly payment.
15-Year Fixed Rate
Now let’s run the same exercise with a 15-year term instead of 30 years.
- FHA Loan: 5.250% rate, 6.480% APR, $15,849 in upfront costs, and a $3,294 monthly payment.
- VA Loan: 5.625% rate, 6.168% APR, $13,414 in upfront costs, and a $3,225 monthly payment.
- Conventional: 4.875% rate, 5.318% APR, $9,146 in upfront costs, and a $3,152 monthly payment.
*Note that the 15-year mortgage will have a roughly $1,000 higher monthly payment, but will pay off the entire loan in half the time. Also, the conventional loan option had the highest rate, APR, and monthly payment for the 30-year, but the lowest of all three for the 15-year.
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Higher Cost and Lower FICO Score
Now let’s see what a hypothetical mortgage would cost for a $650,000 loan with a 680-699 FICO score and the same 13% down payment ($84,500):
30-Year Fixed Rate
- FHA Loan: 5% rate, 5.984% APR, $21,688 in upfront costs, and a $3,413 monthly payment.
- VA Loan: 5.125% rate, 5.412% APR, $17,893 in upfront costs, and a $3,079 monthly payment.
- Conventional: 6% rate, 6.612% APR, $12,220 in upfront costs, and a $3,734 monthly payment.
15-year Fixed Rate
- FHA Loan: 5.250% rate, 6.457% APR, $22,129 in upfront costs, and a $4,758 monthly payment.
- VA Loan: 5.625% rate, 6.146% APR, $18,611 in upfront costs, and a $4,658 monthly payment.
- Conventional: 4.875% rate, 5.325% APR, $12,520 in upfront costs, and a $4,591 monthly payment.
Current Rates for an ARM
With the rates currently higher than they have typically been in quite some time, Adjustable Rate Mortgages are not as prevalent as they once were. The average rates today for an ARM listed by Bankrate with a 740 FICO score to purchase a single-family residence are:
- 5/1 ARM: 5.79% rate, 7.49% APR
- 7/1 ARM: 6.47% rate, 7.37% APR
- 10/1 ARM: 6.74% rate, 7.29% APR
There is a lot to consider when looking to buy a home, especially as active duty military and veterans who have access to the VA loans that civilians do not. The complexities can often be overwhelming since there are so many variables involved that may radically alter the amount of your down payment required, upfront costs, monthly mortgage payments, and how much you ultimately pay for your home.
As with any investment, the best thing that you can do when considering purchasing a home is to perform your due diligence to find the right offer that aligns with your financial situation. There are online mortgage calculators, online mortgage providers, and even mortgage brokers who can help you shop for the right loan if you prefer to arrange your mortgage in person.
Keep this article bookmarked so that you know what you’re looking at when shopping for a home loan, and share it with any friends who may be coming up on their PCS or are looking for a new home. We hope that it has helped you better understand the terms used for mortgages and that it makes your home buying experience easier!