You have a lot of options when it comes to choosing a home loan in California. First-time buyers, in particular, can feel overwhelmed by the many different mortgage loan options. But have no fear. By the time you finish this brief tutorial, you’ll have a firm grasp on the different types of home loans in California.
California Mortgage Options & Types of Home Loans
Let’s start with the good news. Choosing a type of home loan can be boiled down to two overriding decisions. Do you want a conventional mortgage loan, or one that is backed by the government (like FHA and VA)? Secondly, do you prefer a fixed mortgage rate that stays the same over the long term, or an adjustable rate that might save you money in the short term?
Once you answer these two questions, you’ll have a much easier time choosing a type of home loan in California. So let’s look at these options in more detail.
Option 1: Conventional vs. FHA and VA
A conventional mortgage loan is one that is not insured or guaranteed by the government. This distinguishes it from FHA and VA loans, which do receive government backing. This is one of your first mortgage options, when choosing a home loan type in California. Here’s a quick look at conventional, FHA and VA mortgage loans.
- Conventional — This is a “regular” home loan. It is not insured or guaranteed by the federal government. Conventional mortgage loans can either have a fixed or adjustable interest rate, which we will discuss in more detail below. If you use a conventional home loan and put down at least 20%, you can avoid the extra cost of mortgage insurance. But there are lower down payment options as well, sometimes as low as 3%. Here’s a list of conventional conforming loan limits for all California counties.
- FHA — An FHA loan is originated by a lender in the private sector, just like the conventional home loan option mentioned above. But the difference here is that the mortgage loan is insured by the federal government, via the Federal Housing Administration (FHA). Borrowers who choose this type of California home loan can put down as little as 3.5% of the purchase price or appraised value. Additionally, the qualification criteria for FHA can be less stringent than conventional financing, due to the government insurance.
- VA — This is another type of government home loan, and it’s available to most California military members and veterans. We are passionate about the VA loan program, because it essentially rewards the brave men and women who serve our country. This California mortgage option allows eligible borrowers to buy a home with no down payment whatsoever, and sometimes without mortgage insurance. Here’s a list of VA loan limits for all California counties.
So which type of home loan is right for you? Well, if you’re a member of the military, you can’t beat the zero-down-payment benefits of the VA mortgage program. Home buyers with limited funds for a down payment (and / or credit problems in the past) might want to look at the FHA loan program. Home buyers who can afford a 20% down payment might consider using a conventional loan in order to avoid mortgage insurance.
Option 2: Fixed vs. Adjustable-Rate Mortgages
You have another set of options when choosing a type of home loan in California, and this one pertains to the mortgage rate itself. You can choose a rate that is either fixed or adjustable. And there are pros and cons on both sides of the fence.
Here’s the difference between these two mortgage types:
Fixed-Rate Mortgage (FRM)
This type of California home loan has the same interest rate for its full term or “life.” The rate remains fixed and unchanging, hence the name.
The obvious benefit here is that the rate, and the monthly payments, will stay the same over time — even if the loan’s term is 30 years. The downside is that you might pay a slightly higher rate in exchange for this long-term payment stability.
For many people, this kind of trade-off is worth it. That’s why the 30-year fixed-rate mortgage is by far the most popular type of home loan in California.
Adjustable-Rate Mortgage (ARM)
This type of California home loan has a rate that can adjust or change over time. The mortgage rate can rise or fall with market conditions, and is usually associated with a certain “index” like the London Interbank Offered Rate (LIBOR).
These days, most adjustable-rate mortgage loans are “hybrids.” They get this name because they start off with a fixed rate of interest for a certain period of time, after which the rate begins to adjust. For instance, a 5/1 ARM loan starts off fixed for the first five years (indicated by the ‘5’ in the designation), after which the rate adjusts annually (indicated by the ‘1’).
You might wonder why someone would choose this type of California mortgage loan. Why would a homeowner want an interest rate that can change over time, and possibly go up? The reason is that there is a potential for savings in the short term. The initial rate on an ARM loan is usually lower than the rate assigned to a fixed home loan. So a borrower could potentially save money during the first few years of an ARM.
The chart below shows average mortgage rates in three loan categories, over the last year or so. As you can see, the 5/1 ARM loan tracks well below the 30-year fixed mortgage, in terms of average rates. This shows the potential for savings, as mentioned earlier.
Many borrowers who use adjustable-rate mortgages plan to either refinance or sell their homes before the initial fixed-rate phase has passed, avoiding the uncertainty of the adjustment phase. This is a common strategy for ARMs.
To recap: ARM loans generally start off with a lower rate than fixed-rate mortgages, but they have the uncertainty of adjustments later on. Fixed home loans are more stable and predictable over the long term, but might result in higher interest costs over time. So it really comes down to your priorities, and your long-term plans.
We Can Help You Choose
As you can see, you have a lot of mortgage options when choosing a home loan type in California. The good news is that you don’t have to do it alone. We can help you choose the best mortgage product or program for your particular needs. We’ve been helping California home buyers for more than 15 years, and we welcome the chance to help you as well.