Buying a home can be the most stressful event in an individual’s life. From choosing a home that will hopefully increase in value, to choosing a home in a good neighborhood, the decision is not easy. In addition, if you have children, you want to make sure that the school district is a good one, and will continue to be a good one 10 years from now when the children are in high school. And, of course, let us not forget making sure that there are no hidden problems with the newly chosen home.

Of course, once all of those decisions have been overcome, then comes the biggest and most important decision of all: how to pay for home. If you have a limitless checkbook, simply write a check and save yourself a lot of trouble. However, for most of the rest of American, financing is the only way to own a home.

The problem arises, however, when the choices of finance options are presented to the perspective homebuyer. Many people think that financing a home is similar to financing a car—expect with a much long period of payments.

In reality, there are many types of loans that can be used to finance the purchase of a home. In fact, having an understanding of these options can actually mean the difference between buying the home of your dreams, or renting the apartment that you can only afford.

It is also important to remember while there are many ways to finance a home, not all mortgage companies or brokers know of, or have access to all of these options. As with anything else, it is good to go into any discussion about home financing asking a lot of questions. The first person with whom you speak may not be the best person for your particular situation.

Fixed-Rate

Probably the most well known home loan type is the fixed-rate mortgage. This type of mortgage is simply what it says: a mortgage with a fixed interest rate throughout the entire length of the loan. The advantage of a fixed-rate mortgage comes during periods when interest rates are low. If you can lock-in a 5% or 5.5% interest rate and know that you will stay at that level for 30 years, you don’t have to worry about the possibility of rising interest rates or inflation.

Adjustable-Rate

An adjustable-rate mortgage (ARM) may seem simple at first: a mortgage with an interest rate that increases over a period of time. In reality, however, there are several important things to understand about an adjustable mortgage that can be helpful to the home buyer, especially the first time home buyer on a limited budget.

Typically, an adjustable-rate mortgage has an initial interest rate that is lower than a fixed-rate mortgage. In addition, they come with a period of time when the initial interest rate will remain the same before it can increase.

Usually, adjustable rate mortgages come as 1/1 ARM, 3/1 ARM, and a 5/1 ARM. This means that for the first three or five years, the lower interest rate remains the same. After that, the interest increases every year up to a predetermined maximum.

As was stated earlier, the advantage of an adjustable-rate mortgage is the fact that loan comes with a lower interest rate for the first few years. However, people can get themselves into trouble with an adjustable-rate mortgage by forgetting that the interest rate will go up.

A person can afford more house during the first few years of the loan. However, unless their income increases—or their bills decrease—they can quickly get themselves to a place where they literally cannot afford their mortgage after a few years.

The key to an adjustable-rate mortgage is to use the lower initial interest rate to assist with the transition from apartment living to the expense of owning a home. It is not an excuse to buy more home that your wallet can realistically afford.

No-Doc Loans

A no-doc loan is actually what it sounds like: a loan that requires literally no documentation from the borrower. These types of loans are for people who want to guard their privacy by not having to give two years worth of tax returns, or divulge W-2’s and 1099’s to a mortgage broker.

Of course, with every advantage comes a disadvantage. The downside to a no-doc loan is that a very high credit score is required. Because the lender only has the value of the property to be purchased and the credit score of the borrower, the credit score becomes the central focus of the lending criteria.

A person with less that absolutely perfect credit probably should not attempt such a loan.

Stated-Income Loans

A stated-income mortgage is for people who actually make a dependable salary, but the salary is not easily documented. People who work almost entirely on commission are good candidates for this type of loan.

When applying for a stated-income mortgage, the lender is going to ask for a full list of assets and liabilities. Of course, the liabilities typically come in the form of debt. This is to determine if you debt-to-income ratio is small enough to allow for the borrower to afford the payments.

The interest rate on a stated-income mortgage is usually a point or more above the interest rate of a comparable fixed or adjustable-rate mortgage. The credit score requirements for a stated-income loan are not nearly as strict because much more information has to be provided to the lender.

One of the problems that can arise from a stated-income loan is probably quite apparent: people can lie about their income. Especially for people with good credit, the borrower can overstate their income in order to borrow more money in order to buy a bigger and better house.

However, the reality of lying on a stated-income loan can quickly come to light when the borrower is unable to pay for their new purchase. Buying that big house may impress your friends, but it will be a blow to the ego when the home is taken away because you can’t afford the payments.

No-Ratio Loans

A no-ratio loan is intended for people who do not want to, or could not, easily disclose their income. When considering the risk of this loan, the lender looks at the assets of the borrower—such as property ownership, business interests, stocks, bonds, and money in the bank.

In addition to people with lots of assets, this type of loan is also good for a person who has good or excellent credit, but is going through a major life change—such as changing careers or experiencing divorce.

In the end, the choice of which mortgage option is right for you should be made only have careful consideration, and after talking to a qualified professional. The decision to buy a home is not one that most people take lightly. The mortgage option that goes along with the house should also be something that is taken just as seriously.