How to decipher mortgage financing options

July 15, 2015

 

michael blower

Michael Blower

The dream of home ownership is shared by legions of Americans, but many are stopped at the front door for fear of not being able to secure financing. What are your options? More than you think!

From fixed rates to adjustable rates, from conventional to government-insured loans, there is a lot to consider when finding the financing that best suits your needs and your circumstances.

Fixed versus adjustable loans

The first consideration is the type of interest rate that makes sense for you. Mortgage loans will offer either fixed-rate terms or adjustable rates, or a combination of the two.

Fixed rate loans have the same interest rate for the entire repayment term. Because of this, the size of your monthly payment will stay the same, month after month, and year after year.

Adjustable rate mortgage (ARM) loans have an interest rate that will change or “adjust” from time to time. Typically, the rate on an ARM will change every year after an initial fixed period. It is therefore referred to as a “hybrid.” A hybrid ARM loan is one that starts with a fixed or unchanging interest rate before switching to an adjustable rate.

How do you decide which is best for you? While the ARM loan will start off with a lower rate than the fixed rate loan, you will face the uncertainty of adjustments later. If you intend to stay in a home for a long time, this may not be the best choice.

With a fixed loan, your rate and monthly payments will not change, providing a certainty that many homeowners prefer. However, that stability comes with higher interest charges than those of an ARM-type loan.

Conventional versus government-insured loans

Conventional loans offer a fixed interest rate over five, 10, 15, 30 or even 50 years and typically require a 20 percent down payment. However, you can put as little as 10 percent down.

If you put less than 20 percent down, you will be asked to carry private mortgage insurance (PMI), which increases your monthly payment.

Conventional mortgage loans must adhere to guidelines set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) and are available to everyone.

Government-backed mortgage loans include FHA and VA loans.

FHA loans are secured through the Federal Housing Administration (FHA) and are designed to help low- to moderate-income homebuyers purchase homes with low down payments (approximately 3.5 percent). These loans are available to all types of borrowers and require you to pay mortgage insurance premium as part of the loan.

Veteran Affairs (VA) loans allow veterans or their spouses to buy a home with no down payment. According to the U.S. Department of Veterans Affairs, the VA does not set a cap on how much you can borrow to finance your home. However there are limits on the amount of liability the VA can assume, which usually affects the amount of money an institution will lend you.

The basic entitlement available to eligible veterans is $36,000. Lenders will generally loan up to four times a veteran’s available entitlement without a down payment, provided the veteran is income- and credit-qualified, and the property appraises for the asking price.

Other loan options

In rare cases (FHA- and VA-insured mortgages only), a loan can stay with the property and be transferred to a qualified homebuyer. This is called an assumable loan.

According to the U.S. Department of Housing and Urban Development, those wishing to assume a loan must still go through the credit verification process, in addition to meeting other conditions. There are several key factors, such as interest rates, time left on the mortgage, amount of down payment, etc., in determining whether this type of loan makes sense.

Partnering with real estate and financial professionals is paramount if you are considering this option.

Another possibility, albeit a riskier one, is the balloon loan, in which the buyer only makes interest payments during the term of the loan, with the balance due in full at the end of the loan term.

While loan pre-approval is an essential early step in the home buying process, you must still get full approval of your loan application. You will be required to provide the supporting documentation that was referenced in your pre-approval application.

There are four possible outcomes: approved, approved with conditions, suspended (where more documentation is required before a decision can be rendered), or denied. In most cases, applications will be approved with conditions, so satisfying those conditions is important to getting your application approved. You will also need to lock in your interest rate and loan terms.

Once your loan is approved, it’s time to celebrate the fact that you are ready to join the ranks of homeowners!

Michael Blower is president of the Central Valley Association of Realtors and an agent with Grupe Real Estate. You can reach him at mblower@gogrupe.com.

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