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Financing a home purchase should be black and white, don’t you think? Most other transactions are a simple swiping of a credit card, or these days, just a tap or a flash of your watch even! Then again, most purchases aren’t hundreds of thousands of dollars. Paying for a home is much more complicated than most transactions.
Home financing options break down into three main categories. Within those are a dozen types of loans.
Home Financing Overview for Military Home Buyers
The Basic Types of Home Loans
Conventional loans are loans not offered by the government. Within these types of loans, you’ll find two main options—conforming and non conforming.
Conforming: Conforming loans are any type that doesn’t exceed Fannie Mae and Freddie Mac’s guidelines.
“Fannie and Freddie are legally bound to purchase various types of mortgage loans under a certain value, known as the ‘conforming loan limit.’ The FHFA sets the national conforming loan limit. For 2020, the limit is $510,400 — but it can be more in some high-cost markets.” — Nerd Wallet
Non-Conforming: Loans that exceed the conforming limit are considered non-conforming or jumbo loans. While you’ll notice a fluctuation in lender rates, you’re almost guaranteed to see higher interest rates as the lender is assuming a larger risk with an increased amount borrowed.
The fixed-rate loan is one of the most popular lending options. Here’s why the interest rate doesn’t change over the typical 15- or 30-year life of the loan. Since your interest rates are immune to market fluctuations, it offers predictability and stability—which also makes for easy budgeting. Borrowers have the option to refinance if the interest rate drops significantly and often choose a fixed rate if they believe they’ll remain in the home for the majority of the loan’s term.
A fixed-rate mortgage is best for homeowners who plan to be in the home for the majority of the loan since equity usually takes longer to build.
Adjustable Rate Mortgages, or ARMs, are also referred to as hybrid loans because they contain a mix of fixed and adjustable rates. Although an ARM’s interest rate may initially be lower than a fixed-rate loan, the interest will fluctuate to reflect the national interest rate at that time.
If the current interest rate is more than the initial rate, the payments increase. If it’s lower, the payments decrease. The adjustment periods are predetermined (often about five to seven years) and have minimum and maximum rate restrictions to control the size of the adjustment.
“Most banks will start an ARM at a lower interest rate since you are absorbing the market’s shifts. If you plan to only own the home for a few years before selling it (because you’re military and move frequently), you may not even feel a shift in the market—the chances of an astronomical increase in the market within the few years you plan to own the home are minimal.” — Pros & Cons of an Adjustable Rate Mortgage for Military Homebuyers
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Government Backed Home Loans
The FHA Loan
The Federal Housing Administration funds the FHA loan. This loan has a down payment for as little as 3.5% of the home’s price, making it attractive to first-time homebuyers or those who haven’t been able to save enough for a conventional home loan.
2020 requirements for an FHA loan:
- FICO® score of at least 580 = 3.5% down payment.
- FICO® score between 500 and 579 = 10% down payment.
- MIP (Mortgage Insurance Premium ) is required.
- Debt-to-Income Ratio is < 43%.
- The home must be the borrower's primary residence.
- The borrower must have a steady income and proof of employment.
The VA Loan
“In 1944, The U.S. Department of Veterans Affairs created the VA loan as part of the Servicemen’s Readjustment Act to assist WWII veterans with establishing homeownership. President Roosevelt signed the act with the hope that service members would come home and begin to establish new lifestyles after sacrificing so much during the war effort.” — What Is a VA Loan?
Today, the government has funded more than 22 million VA loans, and the program remains one of the most powerful for helping active-duty service members and veterans achieve homeownership.
What the VA loan offers:
- Favorable interest rates.
- Zero down payment.
- Private mortgage insurance is not required.
- Reduced closing costs.
- No prepayment or early pay-off fees.
VA loan eligibility:
- Active Duty members with a statement of service.
- Veterans with the Certificate of Release or Discharge from Active Duty Form DD214.
- Spouses of military members who’ve died on Active Duty or as a result of a service-connected disability.
The USDA Loan
“The USDA loan’s purpose is to provide affordable homeownership opportunities to low-to-moderate income households to stimulate economic growth in rural and suburban communities throughout the United States.” — USDA Loans
Borrowers can apply for a USDA loan without a down payment and reduced interest rates.
USDA loan eligibility requirements:
- Must be a U.S. citizen or legal permanent resident.
- Must show creditworthiness (credit score of at least 640).
- Must have a stable and dependable income.
- Must have a willingness to repay the mortgage.
- The household income must be equal to or less than 115% of the area median income.
- The property must be a primary residence and be in a qualified rural area.
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Other Types of Home Financing
1) Construction loans: Created to fund the construction of a new home, these loans typically involve a higher interest rate and a shortened lifespan (usually a year for the time it takes to build the property).
Primary types of construction loans:
- Construction-to-permanent: allows you to borrow money to build your primary residence, and, once completed and moved in, the loan evolves to a permanent loan.
- Construction-only: covers the cost of building the property but requires you to either pay your debt in full at the end of the term or get another mortgage.
- Renovation: allows you to borrow money to make improvements and updates to a preexisting property.
2) Interest-only mortgage. With an interest-only mortgage, your monthly payments are only enough to cover the interest for a fixed period. Then, you’re required to pay off the full sum either as one big lump or with revised (usually increased) monthly payments with higher interest rates. This type of financing makes it harder to earn equity and takes longer than other, more traditional home loans.
3) Balloon mortgages. Balloon mortgages begin with low or monthly payments (or none at all). Then, like the interest-only mortgage, at the end of a set amount of time, they require a large payment to pay off the remaining amount of the loan. This type of loan is most often used by those who are confident that they’ll be moving on and selling the property in a few years.
4) Owner financing. When the buyer finances the property directly through the buyer instead of obtaining a conventional home loan, it’s called owner financing.
“With owner financing, also called seller financing, the seller doesn’t hand over any money to the buyer as a mortgage lender would. Instead, the seller extends enough credit to the buyer to cover the purchase price of the home, less any down payment, and then the buyer makes regular payments until the amount is paid in full. The buyer signs a promissory note to the seller, which spells out the terms of the loan, including the interest rate, repayment schedule, and the consequences of default. The owner sometimes keeps the title to the house until the buyer pays off the loan.” — Jean Folger, The Pros and Cons of Owner Financing
These deals are often short-term and end in a balloon payment. The purpose? To allow the buyer time to get their finances in order so that they may qualify for a traditional loan.
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Choosing a Home Loan That's Right for You
With so many options, how do you choose the loan that’s right for you? Start with running your numbers through a home loan calculator like Mortgage Calculator.
First, you need to determine what you need most. If you’re military and plan to sell in a few years when you PCS to your next duty station, you might prioritize a loan that starts with lower payments, as you can likely avoid the big balloon payment required further down the road. However, you risk assuming more debt if the home doesn’t sell as planned.
If you plan on holding onto the home indefinitely (maybe turning it into a rental investment property), then a mortgage with a higher monthly payment and less interest overall might be best. This set up often allows you to build equity faster.
To recap, when you’re looking at a home loan, here are the basics you need to compare:
- Loan Life.
- Interest Rate/Annual Percentage Rate (APR).
- Total Amount.
- Monthly Payment.
Once you figure out which financing option is best for you and your family, then you get to move on to the good stuff, finding your next home! When you’re ready, begin your home search with MilitaryByOwner.
And if you have any questions or need a little guidance (the homebuying process can be overwhelming, especially for first-time homebuyers) we’re here for you. Find practical help on our home buying resource page and follow our blog for even more tips!
By Danielle Keech
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