Mortgage options for Home buyers and Refinancers
Updated: Mar 10, 2022
What is a mortgage?
The term mortgage is the term defined as the loan used to purchase or maintain a home, land or other types of real estate. It is an agreement between the borrower and lender to pay the loan over a period of time in a series of regular payments with principal and interest. These are called as secured loans and the home serves as a collateral. The lender ensures that the borrower meets certain requirements such as credit score, credit history, debt to income ratio, down payment etc. The requirements are checked through a process of underwriting before the loan is sanctioned. There are various types of mortgages such as conventional loans, government backed mortgage loans etc.
30 year Fixed mortgage
30 Year fixed mortgage is defined as the mortgage which has the fixed interest rate and the monthly mortgage payments stay same for the entire term of 30 years. The monthly payment is low and the repayment period is longer. This loan is usually the preferred loan by many people.
The loan has smaller monthly mortgage payments which makes it easier to qualify and easier to pay. There is a flexibility to pay off the loan faster by making extra payments to your regular monthly mortgage payments. There is a chance to qualify for more expensive home. As the monthly mortgage payments are smaller, you may have extra money to invest in other areas of your interest.
During the initial years of the loan, majority of your monthly mortgage payment is towards the interest payment. The total interest paid is higher than short term loans thus making the equity growth slower. The lender's risk of not getting paid is spread over 30 years, thus the lenders charge higher interest rate. You may be qualified for much expensive home, but due to a bigger home, your property tax, insurance and maintenance costs may be higher which may not be suitable for many.
15 year Fixed mortgage
15 Year fixed mortgage is defined as the mortgage which has the fixed interest rate and the monthly mortgage payments stay same for the entire term of 15 years. It is suitable for buyers who can afford higher monthly mortgage payments and helps payoff the mortgage in half the time. This is mostly done by Refinancers. Learn more about 15 Yrs fixed mortgage here.
As the lender's risk of not getting paid is spread over shorter period compared to the 30 year loan, the interest rate is usually lower than the 30 year fixed mortgage loan. Less money goes towards the interest, thus making the equity growth faster. As the money going to the interest payment is lower, it may be considered as the long term savings.
It has a larger monthly mortgage payments compared to the 30 year loan and along with the property tax, insurance and maintenance costs, it makes a huge monthly investment. On top of that, if your down payment is lesser than 20%, you may have to pay additional Private mortgage insurance (PMI). Higher monthly mortgage payments makes less qualifying for a high priced home. If you have a variable income, it may be a risk to get 15 year fixed mortgage.
Adjustable rate mortgage
Adjustable rate mortgage is a type of loan where the initial rate is fixed for a certain time, then varies periodically based on the terms of the loan chosen by the borrower and the benchmark interest rate chosen by the lender. For example, 5/1 ARM has an initial interest set for first 5 years, then the interest changes periodically.
The interest rates are usually lower than the interest rate on the fixed rate mortgages. In 5/1 ARM, the interest rate is locked down for the first 5 years to a lower rate. If you are buying a home for a short period of time and then planning to sell or move, then ARM loan may be the best suit for you. The mortgage payments may decrease if the interest rate falls and drives down the index.
Some ARM loans include a prepayment penalty, this is a fee that may be charged while selling or refinancing your home within a specific time period. It is very important to be aware of all the rules, penalties and structures of the loan and may cause a risk if not properly understood.
Jumbo loan is a type of mortgage which is used to finance properties which are too expensive for the conventional conforming loan (exceeds loan limit) standards set by Federal Housing Finance Agency.
Jumbo loans makes the buying of expensive home possible as the loan limits are higher than the conventional loan limit. Jumbo loan helps in financing the property under a single mortgage instead of multiple loans to finance a mortgage. Jumbo loans usually have a 5% or 10% down payment which is lower when compared to the conventional loans.
As the Jumbo loans pose a credit risk to the lenders not only because of the high loan amount but also it cannot be packaged as a mortgage backed security and thus they charge a higher interest rate. Not all the properties get qualified for the loan, needs a very good credit score to be qualified for the loan and may also have high closing costs. Gift funds may not be eligible for down payment.
Interest Only Loan
Interest only loan is a type of loan where the monthly payment is made only on the interest of the loan and the principal is not included and thus the loan balance is not reduced.
It is best suited for the borrowers whose income changes from month to month and for borrowers who get a huge annual bonus at the end of the year and plan to bring the principal amount down. It is also fit for the borrower who does not plan to live in the home long term.
It is very important to be disciplined and need a good planning to pay down the principal amount periodically.
Government backed mortgage
Government backed mortgage are the type of mortgage which is secured by the federal agency. There are 3 types of loan namely FHA, VA, USDA. Depending on the borrower's situation, they may qualify for one or more. It is easier to qualify for these types of loans when compared to the conventional loan. Even though these loan are secured by federal agency the same mortgage agent can facilitate the loan.
It is a type of loan when the loan in insured by the Federal Housing Administration. FHA loans are possible with a minimum down payment of 3.5% and credit scores of as low as 580.
With credit score of 500 - 579, you may be eligible with a 10% down payment. The debt to income ratios are also higher than conventional loans.
The property (home, multifamily, condo, town home, manufactured home) that the borrower is planning to buy must meet the standards outlined by the FHA. There is an upfront mortgage insurance premium that has to be paid initially or can be rolled into the loan. The loan amount cannot exceed the conformed limit on that area.
VA loans are the type of loans guaranteed by Department of veteran affairs and are funded by private lenders. These loans are available to the military service person or veterans who meet certain requirements. VA guarantees to pay the loan amount if the borrower defaults to repay. There is no down payment or mortgage insurance required as defined in the FHA loans. VA loan requires a one time Funding fee required. The property must meet the building standards and building codes and must be a Primary residence.
USDA loans are the mortgage guaranteed by the Department of Agriculture and are available to the rural home buyers who meet certain requirements. The criteria by which the loan is issued are credit score, debt to income ratio, location of the home etc. It has a 0% down payment and are designed for the people who are not wealthy and are unable to get a conventional loan. There are income limit eligibility and there is a limit on the property value. Loan is also available for home improvement purposes.