Browsing online and visiting open houses is probably the most exciting and easiest part of searching for a new home. But the hard work of finding the mortgage that fits your financial needs is yet to come. Lifestyle choices, such as how long you’ll live in the house, if the property is a fixer upper, or if it has potential to be rental income, are just a few of the factors that will make up the mortgage equation.
To understand the types of home loans available will take some time and likely the help of a real estate pro and/or a mortgage banker, but here is a quick breakdown of the most common choices available.
- All loans are either conventional or government-backed loans.
- Most government and conventional loans offer two rate structures: fixed rate or adjustable rate mortgages.
- There is a choice between a conforming loan and a jumbo loan, depending on the size of the loan needed.
Fixed Rate Loan
The fixed rate loan is one of the most popular lending options. The interest rate does not change over the typical 15- or 30-year loan time (the interest rate on a 15-year fixed loan is lower than a 30-year loan), so homeowners who prefer predictability choose this option because varying interest rates never affect their payments. 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.
Adjustable Rate Mortgage
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, after a set amount of time, such as 5 or 7 years, the interest will move to reflect the national interest rate at that time. If the current interest rate is more than initial rate, the payments are higher. If it’s lower, the payments decrease. The adjustment periods are predetermined and have minimum and maximum rate restrictions to control the size of the adjustment.
Applicants can potentially qualify for a larger loan because of the lower interest rates an ARM offers. Military members are sometimes drawn to these types of loans if they are confident they’ll move and sell the home before the fixed interest rate schedule adjusts.
It’s common to see ARMs described in this way:
- 7/1 ARM: loan has a fixed interest rate for the first 7 years, then adjusts annually.
- 5/1 ARM: loan has a fixed interest rate for the first 5 years, then adjusts annually.
- 1-year ARM: loan has a fixed interest rate for the first year, then adjusts annually.
Government Backed Loans
Federal Housing Administration Loans
A favorable feature of the FHA loan is the ability to use less than 20% for a down payment, even as low as 3.5 percent. However, the loan does come with some restrictions. Interest rates are normally static with 15- or 30-year terms, and homeowners are required to provide mortgage insurance either upfront or throughout the term of the loan. These fees might make a conventional loan more affordable if it is a possibility. First-time homebuyers and those with less than ideal credit scores often qualify for a FHA loan.
203k FHA Loan
This loan is designed to help those who are interested in refurbishing a damaged or older home, but the property does have to qualify under normal FHA requirements. The money borrowed equals the cost of the property plus the cost of the repairs. Many times, a 20% contingency reserve is included to make sure enough money is available if costs go beyond estimates.
This loan is further broken down into two types: standard and limited. The standard 203k allows for options like structural repairs and landscaping. The limited is geared toward upgrades that conserve energy like roofing and updated appliances which are not structural. These loans will not cover any improvement that will not permanently be part of the home. In addition, hobby or luxury upgrades such as a pool or a basketball court are not covered.
Applying for the 203k loan is time consuming because professional proposals and cost estimates are required to be part of the application process.
Veterans Affairs Home Loans
Military service of 90 days of consecutive wartime service or 180 days during peacetime (Reservists need 6 years) is required for eligibility for a VA loan, but the benefits are tremendous.
Borrowers do not have to supply a down payment or provide mortgage insurance. The VA limits the type of property it will back, meaning the house has to be the primary residence and it cannot be in a condition less than their established minimum requirements, thus exempting property that needs extensive renovations.
United States Department of Agriculture and Rural Development Loans
Originally created to help low to moderate income families in rural areas, a USDA loan helps borrowers afford a home purchase or repairs and renovations. Borrowers can apply for a USDA loan without a down payment and reduced interest rates. They are required to supply mortgage insurance and their debt-to-income ratio is scrutinized. USDA borrower’s debts cannot surpass their income by more than 41 percent.
Conforming or Jumbo Loans
Conforming loans are any type that follow Fannie Mae and Freddie Mac’s conforming guidelines. Credit, income, asset requirements, and loan amount all constitute what guidelines are considered. In 2017, the loan maximum was $424,100, with exceptions made for higher cost of living areas.
Speaking of Fannie Mae and Freddie Mac….just who are they?
Congress established both corporations to provide lending institutions the ability to secure the housing finance system through attainable funding by ensuring banks and mortgage companies have money to lend to home buyers. Both Fannie and Freddie buy and sell mortgage backed securities (MBS). In other words, they buy loans from lenders and later sell them to Wall Street investors.
Jumbo or non-conforming loans offer borrowers the opportunity to afford a high-priced home if their current finances predict unhampered repayments. Interest rates are typically higher than a conventional loan, and often necessitate large down payments and near perfect credit, making qualification difficult.
There is certainly much to be considered before applying for a home loan. Often, it’s best to research which types of loans fit the circumstances of your family both financially and geographically before actually setting out and reviewing properties online or shopping Sunday afternoon showings. Knowing your personal parameters will restrict unattainable house options and lesson disappointment later.
By Dawn M. Smith