MORTGAGES: Choosing the right one for you
Finding a new home can be stressful enough without having to worry about financing. Itβs easy for homebuyers to become confused by the language real estate agents and lenders use during the mortgage application process. Understanding a few simple terms may demystify the process and help you rest at ease with the terms of your home loan. Whether you're buying your first house or upsizing to a larger one, you'll find plenty of loans to finance your purchase. Lenders will likely ask about your housing plans and your career plans to help you find the best option for your situation. The biggest choice is between a fixed-rate and adjustable-rate loan, but other factors play into the loan equation.
While researching lenders, it's important to realize that not all are created equal. Some lenders offer only "conventional" or "conforming" mortgages. With such mortgages, the homebuyer must meet relatively strict requirements (called "underwriting guidelines") to qualify for the loan. "Non-conforming" lenders specialize in loans that don't meet standard underwriting criteria. Typically designed for borrowers with a weak income history or a below-average credit background, such mortgages almost always carry higher interest rates than traditional mortgages.
What type of loan should I look for?
The type of mortgage that works best for you will depend on several circumstances, including your income, your existing debt (car loans, credit cards, school loans, etc.), your credit history (how timely you've been with payments) and how much cash you can put toward a down payment and closing costs. However, ultimately a loan should be based on how much you are content with paying each month.
Conventional mortgage
To get a conventional mortgage, you'll first have to meet underwriting guidelines set by the Fannie Mae Foundation, a private not-for-profit company chartered by the U.S. Congress to provide mortgage funds to lenders. Under Fannie Mae requirements, you must contribute at least 5 percent of the home's purchase price as a down payment. Also, your monthly housing costs (including mortgage payments, property taxes and home-related insurance) can be no more than 28 percent of your gross monthly income and total debt (including other loans and credit cards) no more than 36 percent of your income.
FHA mortgage
These loans are government-backed by the Federal Housing Administration. They are available to buyers with little savings for down payments and to those who have been deemed too risky by conventional lenders. FHA loans are very appealing because they can offer 100 percent financing; however, not everyone can meet the requirements.
Monthly housing costs can go as high as 29 percent of your income and total debt can go up to 41 percent of your income. Credit standards on these loans, issued by the Federal Housing Administration, are also more relaxed; closing costs tend to be slightly lower and your down payment can be as low as 3 percent.
Adjustable Rate Mortgage (ARM)
This mortgage loan periodically adjusts interest rates to match market rates. Borrowers often use these loans when interest rates are high but lower rates are expected in the future. This is because the initial interest on these loans is generally lower usually by about 2 percent than interest charged on conventional fixed-rate mortgages.
The catch, however, is that ARM interest rates can fluctuate once a pre-specified period of time has expired. At that point, the loan typically adjusts annually throughout the life of the loan. These fluctuations are controlled, however, by interest caps usually 2 percent annually and 6 percent over the life of the loan.
Fixed Rate (FRM)
The mortgage-payment rate and loan payments remain fixed for the life of the loan, usually 30 years. Shorter term fixed rates (usually 15 or 20 years) carry lower interest rates, higher payments, and less money paid out than with longer-term loan mortgages. Longer term fixed rates have smaller monthly payments and are easier to budget than shorter term mortgage loans.
Balloon
This option gives borrowers lower rates and payments for a specific period of time anywhere from three to 10 years. After that point, the borrower has to pay off the principal (amount borrowed) balance in a lump sum. Under certain conditions, they can be converted to fixed-rate or adjustable-rate loans. Many borrowers either sell their homes before they get to their due dates, or end up refinancing their balances into new mortgages. This is a great mortgage option for buyers who don't plan on living in the property for long.
Jumbo
Considered a nonconforming loan because it exceeds the loan limit set by Fannie Mae and Freddie Mac (the two publicly chartered corporations that buy mortgage loans from lenders), thereby ensuring that mortgage money is available at all times in all locations around the country. If you require more money in your loan, then a jumbo mortgage may be a good option. You'll have the opportunity to purchase larger, more expensive properties.
Assumable
Relatively rare, but a homeowner with an assumable loan can "hand off" the loan to a buyer instead of paying it off using proceeds from the home sale. If rates are low and you can get one, by all means, do so. If rates rise, buyers will be able to assume your loan at the rate you currently pay (and will be willing to pay more for your house) because it will be much cheaper than any loan they could get from a bank or other source. An advantage of an assumable mortgage is that it reduces monthly payments and saves money on closing costs.
Two-step
Combines elements of fixed and adjustable-rate mortgages. Features a fixed rate and payment for an initial period, followed by one adjustment, then a fixed rate and payment for the remainder of the loan term. These mortgages will have names such as 2/28, 5/25 or 7/23. A 7/23 mortgage, for example, has an initial fixed period of seven years, an adjustment, and then 23 more years of payments following the adjustment. These mortgages give borrowers with lower credit scores an opportunity to buy a home and to establish better credit.
Still confused? With so many variables, it's hard to know what loan program will make the most sense for your budget. Schedule a consultation with a mortgage professional for more help. By working together, you're sure to find the package that works for you.
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