Have you been thinking about buying a house but are confused about the process of getting a loan? You’re not alone. Many prospective homebuyers know they have options for financing their home purchase, but they don’t know much else about those options. Similar to landscape businesses, residential development teams utilize tools and data to ensure they’re getting the best return on their investment in their projects. Unfortunately, you likely don’t have experience in the world of mortgages, especially if this is your first home or you are buying to manage a rental property for the first time. While most people talk about conventional loans, there are several other types of mortgage loans you can choose from depending on your unique financial situation. Keep reading to learn more about mortgage options.
Elements of a Mortgage
Before we can dive into discussing your mortgage options, you should know a few terms to help you make sense of pre-approval and jargon when discussing your options with a loan officer. Here are the three elements of a mortgage you should know:
The loan type depends on whether there’s a government agency involved in the process and the loan amount. There are several types of loans, including FHA loans, VA loans, conventional loans, non-QM loans, and more, which we’ll discuss in depth later.
Two types of rates are involved with each loan type: fixed and adjustable. You can choose which type you want based on your needs and interest rates at the time of your application. Generally, a fixed-rate mortgage stays the same for the life of the loan, so you’ll always know how much your monthly payment will be. This is a good option for buyers that plan to stay in the home for a long time and want a regular payment they can use to budget their expenses.
Meanwhile, an adjustable-rate mortgage (ARM) stays the same for a set number of years, usually five, seven, or ten, so you’ll know your interest rate for the first few years of the loan. After that set period, the interest rate will go up or down depending on the market’s conditions. This could be a good option for borrowers buying a home when interest rates are high and expect it to fall within a few years, reducing their overall mortgage bill.
The loan term is the length of the loan. In most cases, fixed-rate mortgages are available in 30 or 15-year terms, but some lenders allow you to choose a term from 8 to 30 years, depending on your needs. Meanwhile, adjustable-rate mortgages typically have a 30-year term. A longer term will keep your monthly payments lower, while a shorter term means paying off your loan faster.
Elements of Mortgage Payments
While there are elements of the loan, your payment also has different elements. When you pay your bill, you’ll pay a flat number. However, this amount is split between different parts of the loan, including the principal, interest, taxes, and insurance.
- Principal: The principal goes toward paying down the balance of your loan, which increases your home equity.
- Interest: Interest goes to the lender as a fee for borrowing money from them.
- Taxes and insurance: Taxes and insurance are usually grouped together and include your property taxes and homeowner’s insurance premiums. This part is only included in your mortgage payment if you have an escrow account.
Types of Mortgage Loans
There are several mortgage loan options, and your choice will depend on your unique financial situation. Here are a few of the most popular options:
Conventional loans are not backed by the federal government and are the type with the strictest regulations and requirements regarding credit score and debt-to-income (DTI) ratio. With conventional loans, you can put as little as 3% down, but you’ll pay for private mortgage insurance (PMI) if you don’t have a down payment of less than 20%. Therefore, these loans can actually be more expensive monthly if you don’t have the necessary down payment to avoid PMI. However, insurance rates are typically lower for conventional loans, so there are a few pros and cons.
FHA loans are backed by the Federal Housing Administration (FHA). An FHA loan can help first-time home buyers purchase a home with a lower credit score and down payment of only 3.5%. With an FHA loan, you may be able to buy a home with a credit score as low as 500, depending on your lender and how large the down payment is.
VA loans are another government-backed loan. They’re insured by the Department of Veterans Affairs and can allow veterans and surviving spouses to buy a home with no down payment and low-interest rates. But, of course, borrowers for this loan must meet service requirements.
Jump loans are worth more than many other types of loans, so they’re ideal for high-value properties. Jumbo loan interest rates are similar to other rates, but they’re more difficult to qualify for because you need a higher credit score and lower DTI. In addition, you must have a down payment of at least 10%, but 20% is best.
Non-QM loans, short for non-qualified mortgage loans, are for individuals who fall outside the strict guidelines of standard mortgage programs. The requirements of traditional mortgage loans alienate some potential borrowers because they require pay stubs from an employer, higher credit scores, and higher down payments. Unfortunately, many self-employed borrowers don’t qualify for conventional loans because lenders see them as high-risk since they don’t have regular income like a W2 employee. Luckily, Non-QM loans provide these borrowers with options for home ownership.
There are several types of non-QM loans, including bank statement loans, in which, instead of asking for your W2, a lender will look at your bank statements to ensure you can repay the loan. These loans are ideal for individuals who don’t qualify for traditional mortgage loans, especially if you know you can afford to buy a home but traditional lenders won’t approve your application.
Finding the right home loan for you is crucial. While lenders will ensure you can repay the loan through their various underwriting processes, they don’t know your financial situation as well as you do. The type of loan you choose could make or break your finances, so you must find one that can help you save as much money as possible, even when buying a home. So check out your options and do your research so that you can ensure you have the right fit and can start making upgrades.