Are you considering to buy your first home and wondering about the options?
Well, you're not alone. Many people exist in the same situation, and the dilemmas are more or less common to all of them. In this article, we will give my best to explain mortgages so that you can understand the way they work.
Types of Mortgages
There are various types of mortgage loans depending on different criteria. Nevertheless, the main classification we use is based on the type of interest rate and the type of lender. Thus, we have fixed-rate and adjustable-rate mortgages. Regarding the type of lender, we have mortgages issued by government agencies or private lenders. Below you will find more information about each type.
Fixed Rate Mortgages
These are mortgages whose interest rate remains the same during the whole term. If your rate is 7.5%, it will not change even if interest rates hike. This is a particularly good choice if at the moment of closing the rates are very low. So whatever happens tomorrow (most probably rates will go up again), these changes will not affect your mortgage payment.
Occasionally, the monthly payment might change in the future.
Remember the escrow account? If you have to pay more taxes on your property, therefore the money in the escrow account will increase making the monthly payment slightly higher.
Adjustable Rate Mortgages
Unlike fixed-rate loans, in adjustable-rate mortgages, the bank will change its rates during the term. These specific details will be part of the agreement so make sure you know all of them. For instance, usually, the rate is fixed for the first several years. Then, after this period, the lender changes it and recalculates your monthly payments.
The lender will use an index to recalculate the old interest rate. Despite that, there will be limits on how much the rate can vary. Let’s look at an example illustrating this.
You have a mortgage at a 6% rate for the first three years and an annual cap of 2%. This means that the following year (after the first three), the rate cannot be more than 8%. There is also a percentage cap that shows how much the rate can increase during the whole term. If in the above-mentioned example this cap is 5%, it means that the highest rate you can ever have is 11%.
If a loan is not secured by a government agency (for instance, FHA or VA), then we call this mortgage conventional. Because of the lack of government protection and guarantee, usually, banks impose stricter approval criteria. One of the things the lenders might want is a higher down payment – up to 25%. In addition, if the borrower cannot afford this, the bank will require Private Mortgage Insurance. This is how the lender makes sure their money is protected in case of a default.
The PMI can reach up to 20% of the property’s value, but you don’t have to pay it at once. The lender will include it as a part of your monthly payment.
Mortgages Insured By The FHA
An FHA mortgage is a loan which is insured by the Federal Housing Administration. These loans usually have more affordable terms. Bear in mind that the FHA does not lend you the money but rather ensure the property. Most private lenders offer this type of mortgage.
Borrowers can qualify even if their credit score is lower than 600 and make a very small down payment – below 5%. Although the requirements are less stringent, often the home buyer should pay a 3% cash contribution.
Check the FHA’s official website as well as your bank’s and make sure you know all the requirements and details.
Mortgages Guaranteed By The VA
Just like FHA loans and unlike conventional mortgages, this type is guaranteed by a government body – the Department of Veteran Affairs (aka VA).
If you are a veteran, active-duty service personnel or even veteran spouses, you can qualify for a VA loan. What are the biggest perks of this type of mortgage?
No other loan on the market goes with 0% down payment. This is a huge advantage since many people have no cash whatsoever. In addition, overall the terms are much better than those of conventional loans.
Mortgages Guaranteed by The Rural Housing Service
The Rural Housing Service (RHS), which is an agency part of the US Department of Agriculture (USDA), also offers affordable mortgages to people who live in rural areas. These loans have low-interest rates and people with relatively low income can benefit from them. The most common program is called Single Family Direct Home Loans or Section 502.
Usually, local banks in association with the USDA offer these programs to borrowers.
In order for borrowers to qualify, they need to have low income. In addition, families should not have a house. Some of the benefits include an extended term up to 33 years and no down payment.
Things To Consider
There are a couple of things to pay attention, especially if it's your first time:
A down payment is the amount of money a borrower should pay when closing their mortgage. Usually, banks require no less than 20% of the property’s value. Unfortunately, many people cannot afford this amount of money, therefore pay less. Your bank, consequently, will consider you a riskier borrower and will require additional protection. This will also mean worse terms on your mortgage.
If you pay less than 20% down payment, you will have to pay a Private Mortgage Insurance, which may be up to 20% of the home’s value. This money will be equally distributed each month and included in the monthly payment. There is good news. Once you pay off 78% of the property’s value, this insurance will drop off.
Depending on the city and state in which you buy the property, you will have to pay various statutory costs. Some of these expenses might include transfer taxes, pro-rate taxes, local mortgage fees and others.
Prepare yourself to pay also additional, which we call third-party, costs. If you work with an attorney, you have to pay attorney fees. Attorneys usually charge a small percentage of the property’s price. Other than that, if you have worked with a real estate agent, be ready to pay them a commission. Just like the attorney’s fees, it’s a percentage of the selling price. Some of the lenders can require you to pay the insurance premium for the first year in advance.