By: Amy Miller, AFC®
When ready to purchase a home, choosing a mortgage, determining your down payment, and understanding closing costs are just as important as choosing the neighborhood where you want to live.
Before searching for the perfect home to buy, you will need to navigate through the many moving parts that come along with home buying – a process that can be complicated, especially for first-time homebuyers (remember – that’s about 33%).
This week, again in honor of National Homeownership Month, I thought we would look at a few of the different types of mortgages available and touch on down payments and closing costs.
Conforming or Non-Conforming
All mortgage loans are considered one or the other and is determined by whether your lender will keep your loan on their books and collect your payments or if it will be sold to one of two real estate investment companies – Fannie Mae or Freddie Mac.
Conforming loans are conventional mortgages that can be purchased by Fannie or Freddie from your lender and must meet certain qualifications (like a credit score of 620), cannot be federally backed (like a VA loan), and must be below $647,200 (unless you are in Hawaii or Alaska which are considered high-cost areas and allow for a limit of $970,800).
Non-Conforming loans have less strict guidelines and are typically government-backed or jumbo mortgages. These loans will sometimes also allow for approval with a lower credit score, negative items being reported, or past bankruptcies.
Types of Mortgages
There are many types of mortgages available and the best one for you depends on your individual situation. I’ve outlined a few of the most popular ones below:
Conventional loans are the most common but do have strict guidelines pertaining to credit score and debt to income (DTI) ratios for approval. Down payment requirements are as low as 3% and a minimum credit score of 620 is required.
Government-Backed loans are insured by government agencies and have specific criteria that must be met to qualify. There are three types of government-backed loans – FHA, VA & USDA.
FHA loans are insured by the Federal Housing Administration and can be approved with a credit score of 580 and a down payment of 3.5% or a score as low as 500 with a 10% down payment.
USDA loans help moderate to low-income borrowers buy homes in approved areas with no money down and are insured by the US Department of Agriculture. Income requirements must be met and there are extra fees involved – including an upfront fee of 1% of the loan amount plus an annual fee. (the 1% upfront fee can be financed in with the loan) You can learn more about the loan programs available through the USDA by using this link: USDA Housing Programs
VA loans are insured by the Depart of Veteran Affairs and allow qualifying service members and veterans to purchase a home with $0 down and offer low-interest rates. These loans offer less strict approval guidelines than many other loans and do not require mortgage insurance (also known as PMI). However, there are upfront funding fees. VA loans also require an appraisal. You can learn more about VA loans here: VA Home Loans
Jumbo loans are loans used when you want to purchase a high-value property or if you are in an area with a higher cost of living and home prices are more than a conforming loan will allow (think New York City, San Francisco, etc). Higher down payments and lower Debt-to-Income ratios are typically required.
Fixed-Rate loans offer a set interest rate and monthly payment throughout the life of the loan and typically offer a 15- or 30-year term. A fixed-rate loan is normally the best option for individuals that are planning on staying in the home for a long time or purchasing their forever home.
Adjustable Rate Mortgages (or ARM loans) are the exact opposite and can adjust based on the terms of the loan and the market. They will generally offer a fixed rate for a set amount of time, known as the introductory rate, and will then change with the market for a set amount of time. They will normally have a “cap” that dictates the highest rate that will be charged which could be very high.
Construction Loans are used when you want to build a home. They go through a separate and different process to qualify than a traditional mortgage. Construction loans are short-term loans (most are 1 year in length) that solely provide funds to build a residential property (cost of land, contractor fees, permits, and building materials). They usually have variable rates that are higher than a traditional mortgage loan. Some are structured as “construction to perm” loans, where they are converted to a traditional mortgage once the work is complete, and the home is ready to be occupied.
Lenders
Every lender is different so you will need to do your homework. It’s important to compare, shop, and find the one with the best rates and terms that work for you. Here are a few things to consider:
*Who you will be working with (online or in-person)
*Timeframe – how long the process will take (some move more quickly than others)
*How long of a rate lock is offered (this is when you are “locked” into a rate that cannot change during that specified time frame)
*Interest rates
*Fees
*Down payment and mortgage insurance
Down Payment
The amount of your down payment can affect your monthly payment and budget for decades so deciding how much to put down is a decision that is to be seriously considered. Its effect on your monthly mortgage payment will then affect not only your lifestyle but your long-term finances. A larger down payment will help you appear less risky to lenders (I call it having “skin in the game”….the more you have, the less likely you are to default) and could help you qualify for better loan terms. A down payment of 20% will then exempt you from having to pay mortgage insurance (PMI), which will result in a lower monthly payment.
Closing Costs
Closing costs are fees that both buyers and sellers are subject to and include fees and charges in addition to the purchase price of the home. These fees include attorney cost, realtor commissions, inspections, appraisals, taxes, insurance, and title filing fees. They typically range from 3-5% of the purchase price of the home and vary depending on your location. A lender is required by law to provide you with an estimate of these costs within 3 business days after applying with them. Additionally, a lender must provide you with another disclosure itemizing these fees and charges 3 business days prior to your loan closing.
The buyer typically pays most closing costs, but they can be negotiated with the seller. Negotiation ability will depend on the market and the type of mortgage you have. VA & FHA loans have limits to what sellers can contribute to concessions so again, doing your homework first and knowing what your options are is key.
Be Prepared
Buying a home is a long-term commitment and a huge step in building a financially fit future. Asking the right questions and understanding the process ahead of time will help make it much easier and will set yourself up for financial health & success.
If you are currently shopping for a mortgage, I encourage you to start the process by checking out AMBA’s member banks – you can find the directory here: AMBA Member Banks