This article is part of an ongoing series, in which we address some of the most common questions among California home buyers and mortgage shoppers. This time around, we’ll answer the question: Which type of mortgage loan is best for a first-time home buyer in California, fixed or adjustable-rate?
Best Type of Loan for First-Time Buyers in California
If you haven’t done so already, you might want to read out overview of California mortgage loan options. It explains the different types of loans that are available, and the pros and cons of each option.
The fact that you’re a first-time home buyer, by itself, does not make one type of mortgage loan better than other. You must look beyond your first-time “status” and think about your financial goals and long-term plans. That’s the key to choosing the right type of California mortgage loan.
The length of time you plan to stay in the home (and hold onto the loan) plays a big role in this decision-making process. Knowing this — or at least considering it — will help you choose between a fixed or adjustable-rate loan.
Let’s look at the key differences between these California first-time buyer mortgage options, and the pros and cons of each…
Difference Between Adjustable and Fixed-Rate Mortgages
An adjustable-rate mortgage loan (ARM) has an interest rate that adjusts or changes over time. This adjustment usually occurs once per year. A fixed-rate mortgage, on the other hand, keeps the same rate for the entire term or “life” of the loan, even if the term is 30 years.
Both ARM and fixed-rate mortgages come in several varieties, as explained below:
- ARM: The 5/1 “hybrid” ARM loan is one of the most popular types of adjustable-rate mortgages among first-time home buyers in California. It’s called a hybrid loan because it starts off with a fixed interest rate for the first five years. After that, the rate will adjust annually like most other ARM loans. That’s what the “5/1” designation means. On average, these loans typically start off with lower rates than the more popular 30-year fixed mortgage loan. But you also have the uncertainty of annual rate adjustments down the road.
- Fixed: Fixed-rate home loans are available in different lengths. The 30-year fixed is by far the most popular type of mortgage loan among first-time buyers in California. Home buyers like this product because it offers long-term payment stability and predictability. When you use a 30-year fixed loan to buy a home in California, you’ll know that your mortgage rate and payments will stay the same.
Choose the One That Supports Your Financial Goals
So, which type of mortgage loan is best for a first-time home buyer in California? Fixed or adjustable? This will largely depend on your financial priorities and your long-term plans. Here are some example scenarios to help you understand the pros and cons of fixed versus ARM loans.
Adjustable-Rate Mortgage Scenario
If your primary goal is to get the lowest possible mortgage rate, and you only plan to stay in the home for five or six years, you might consider using a 5-year ARM loan to reduce your interest rate. ARMs are available in other lengths as well.
In this financing scenario, you could secure a lower rate during the first five years of the ARM loan’s term, when compared to a 30-year fixed. And if you only stayed in the home for a few years, you would be out of the loan before it started adjusting. You could also refinance into a fixed-rate mortgage down the road, another common financing strategy.
Fixed-Rate Mortgage Scenario
If monthly payment consistency is your primary concern, and the idea of a mortgage loan with a fluctuating rate concerns you, then you might be better off choosing the 30-year fixed-rate mortgage loan. It’s the most popular financing option among California first-time home buyers for a reason. With this product, your rate and monthly payments will stay the same for as long as you keep the loan.
Down Payment Options
The down payment is another important consideration when choosing a type of mortgage loan. California first-time home buyers sometimes have limited funds saved up for a down payment. If this applies to you, you’ll want to choose a financing option that allows you to put less money down.
The good news is that there’s a lot of flexibility when it comes to down payments. With a conventional loan, you could put as little as 3% down. VA loans offer 100% financing, and FHA allows for financing up to 96.5% of the purchase price. Additionally, most loan programs these days allow borrowers to use gift money for the down payment expense.
Learn more about low-down-payment mortgage options.