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Financing Options for Your New Home
Finding the right home can be a difficult decision, one that takes
significant reflection and research. What area of town do you want to
be in? Is it in the school district you want? What amenities are your
“must haves”? Does it have the number of bedrooms you desire? What’s
the neighborhood like?
Choosing the perfect home for you and your family can be one of the
biggest decisions you make over your lifetime. An equally significant
decision is how you pay for it. Before you jump at the first mortgage
loan you’re offered, make sure to review the variety of options
available to you.
First, the basics: a mortgage is a long-term loan that uses real
estate as collateral and is used to purchase a home. Sometimes, a home
can serve as collateral for more than one mortgage. When this is the
case, the second mortgage, often called a home equity loan, is used to
finance a home improvement project or other major purchase. Mortgages
most often are described by their terms, such as the time frame for
repayment and whether the interest rate is fixed or adjustable.
A potential home buyer who wants to be as ready as possible should
consider checking their credit through one of the credit reporting
services that offer one free report per year. Credit records often
contain mistakes and it would be best to clear these from your record
before you apply for a loan. Also, don’t abandon the hope of buying a
home if your record shows a few blemishes, since many lenders offer
loan programs that can accommodate borrowers with less than perfect
credit. Some programs may have a higher-than-market interest rate
initially, but the rate drops substantially if the borrower pays the
loan on time for at least two years. It would also be a good idea to
gather the records you’ll need for a mortgage application, such as
earnings statements and rent receipts, before going to the builder’s
model home.
Here are some of the most common mortgage options on the market today:
Fixed-Rate Mortgages
With a 30-year fixed-rate mortgage, the buyer pays off the principal
and interest on the loan in 360 equal monthly payments. The monthly
payment for principal and interest remains the same during the entire
loan period.
The 15-year fixed-rate mortgage is paid off in 180 equal monthly
payments over a 15-year period. A 15-year mortgage typically requires
larger monthly payments than a 30-year loan and allows an individual
to pay off a mortgage in half the time as well as substantially save
on interest payments.
Hybrid Adjustable Rate Mortgages (ARMs) and Other ARM Choices
With a fixed-rate mortgage, the interest rate stays the same during
the life of the loan. But with an ARM, the interest rate changes
periodically, usually in relation to a specific index such as the
national average mortgage rate or the Treasury Bill rate.
Hybrid ARMs have become increasing popular among home buyers as an
alternative to fixed-rate and straight ARM loans. A hybrid ARM has an
initial fixed-rate period of five, seven or 10 years, after which the
loan becomes an ARM with annual adjustments. The initial interest
rates for hybrid ARMs are generally lower than 30-year fixed-rate
loans, but higher than one or three year ARMs.
Lenders generally charge lower initial interest rates for ARMs than
for fixed-rate loans. This makes the ARM easier on your pocketbook at
first; it also means that you might qualify for a larger loan because
lenders sometimes make this decision on the basis of your current
income and the first year’s payments.
Against these advantages, you have to weigh the risk that an increase
in interest rates would lead to higher monthly payments in the future.
It's a trade-off: you get a lower rate with an ARM in exchange for
assuming more risk.
Other Types of Mortgages
A balloon mortgage is a non-amortizing loan. In other words, the
periodic principal and interest payments do not pay off the loan. Some
balloon mortgage loans may have a principal and interest payment that
is calculated as if it would pay off the loan in 30 years, but the
loan comes due in five or seven years. Some lenders offer terms for
renewal of the loan at the balloon date if certain conditions, such as
a history of timely payment, are met. Some loans may contain
provisions to be rewritten as 23- or 25-year fixed- or adjustable-rate
amortizing loans with the monthly principal and interest payment based
on the balance remaining on the balloon payment date.
Conventional Mortgages
A conventional mortgage is a loan that is not insured or subsidized by
the government. Lenders typically require a down payment of at least
20 percent on a conventional loan, although you can get a loan with a
down payment of 3 percent or even less if you are willing to pay
private mortgage insurance (PMI). PMI protects the lender if the
homeowner defaults on the loan. Many lenders offer “no down payment”
loans, but these programs are generally available only to home buyers
with stellar credit.
Conventional mortgage loans are typically fully amortizing, meaning
that the regular principal and interest payment will pay off the loan
in the number of payments stipulated on the note. Most conventional
mortgages have time frames of 15-to-30 years and may be either
fixed-rate or adjustable. While most mortgages require monthly
payments of principal and interest, some lenders also offer interest
only and bi-weekly payment options.
FHA-Insured Mortgages
The Federal Housing Administration (FHA) operates several low-down
payment mortgage insurance programs that buyers can use to purchase a
home with a minimum cash contribution of three percent, which can be
applied to pay the down payment and closing costs. The most frequently
used FHA program is the 203(b) program, which provides for low- down
payment mortgages on one- to four-family residences. The maximum loan
amount for a one-family home ranges from $172,632 to $312,895,
depending on local median prices.
FHA-insured loans are available from most of the same lenders who
offer conventional loans. Your lender can provide more details about
FHA-insured mortgages and the maximum loan amount in your area.
VA-Guaranteed Mortgages
If you are a veteran or active duty military personnel, you may be
able to obtain a loan guaranteed by the Department of Veterans Affairs
(VA). VA-guaranteed loans require no downpayment, but may require the
borrower to pay a funding fee.
Rural Housing Service (RHS) Guaranteed and Direct Loans
The Rural Housing Service, which is part of the U.S. Department of
Agriculture, offers guaranteed loans to moderate and low-income home
buyers who live in rural areas. RHS guaranteed loans are offered
through approved lenders, while the direct loans are available through
USDA’s network of state Rural Development offices.
State Housing Finance Agencies
These state agencies often offer loans with lower-than-market interest
rates and favorable terms to first-time home buyers. Local lenders
usually know if housing finance agency funds are available for these
programs, or you may contact your state housing finance agency
directly.
Where Do I Go From Here?
Based on their vast experience, your local home builders help home
buyers find lenders who can help navigate the confusing financing
process. In addition, literally hundreds of mortgage-related resources
are available through the Internet.
Article courtesy of the National Association of Homebuilders.
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