When you are buying a home, it’s likely that you will need a residential mortgage. There are different types of mortgages that you may need to consider based on your unique situation. It is important to shop around and make an informed decision. Also, remember, you are not alone in this. You surely have a lot of people around you who can tell you about taking out a mortgage loan from personal experience. Listen to them, but also educate yourself. This will help you make the best choice for your situation.
Basic Types of Mortgages
There are different types of mortgages available to everyone based on your credit score and then there are some that are only available to certain groups of people.
Conventional Fixed-Rate Mortgage
These mortgages have a fixed rate so they are considered a safe bet due to consistency. The monthly payments won’t change over time and this is the standard mortgage you will likely to be offered if you are a typical candidate. A conventional fixed rate mortgage is available in 10, 15, 20, 30, and 40-year terms. The ones that are the most common are 15 and 30-year terms. For this type of mortgage, you will be required to put down 20% of the home price. If you put down less than this then the lender can require you to have private mortgage insurance (PMI).
There are a lot of pros of these mortgages. These mortgages can be used for a primary or secondary home, along with an investment property. The overall borrowing costs will tend to be lower than with other types of mortgages, even if the interest rate you get is slightly higher. When you have 20% equity in the house, you can ask the lender to stop your PMI. The cons of these loans are that a high credit score is required and there are significant documentation needs in order to establish your employment, assets, and income.
These mortgages are good for a borrower who has an employment history, a stable income, and a strong credit profile. While 20% is required to avoid PMI, as long as you can still put down 3% and have a high credit score you can qualify.
When you get an interest only mortgage, you have the option to only pay the interest portion of the payment during the first five to 10 years. You aren’t required to do this because it can slow down your repayment time but this can be useful. After this time period, the rest of the mortgage will be paid off like a conventional fixed rate mortgage.
There are many different types of these mortgages. These work with the idea that the interest rate will change over time throughout the life of the loan. The interest rate changes based on the economy and the current cost of borrowing money. A common type of this mortgage is a 5/1 loan. With this option, the interest rate stays the same for the first five years, and then the interest rate will change for the remaining 25 years.
You can enjoy a lower fixed rate for the first few years of homeownership, which saves you a lot of money on interest payments. However, monthly payments can be unaffordable if the interest rates go up higher than you expect. This can result in loan default. Home values can also fall, which will make it harder to sell or refinance your home before the loan resets.
You need to be comfortable with a certain level of risk before you get this type of mortgage. If you don’t plan on staying in your home beyond the first few years then this can be a good way to save on your interest payments. However, if you plan to make this home a more long-term investment you need to think about the future.
These are different types of mortgages that are backed and guaranteed by the Federal Housing Administration. Since they come with built-in mortgage insurance to protect against the possibility of you not being able to repay the loan, those without the best credit scores and who can only have a smaller down payment can qualify.
A government-backed loan can help you finance a home when you wouldn’t qualify for other options and the credit requirements are more relaxed. The first time and repeat buyers can use these loans. The mortgage insurance premiums may not be able to be canceled on some loans once you reach a certain point of equity.
An FHA loan works with flexible underwriting standards that allow borrowers to not have high incomes or the best credit. Mortgage insurance can still be required. It’s usually required when a borrower puts less than 20% down. There are different types of FHA loans since the FHA will also insure other loan programs that are offered by private lenders.
FHA 203(k) loans will allow a homebuyer to purchase a home and renovate it with a single mortgage. A current homeowner can also use this program to refinance their current mortgage and add the remodeling projects into the new loan. The FHA Energy Efficient Mortgage program allows a homebuyer to purchase a home that is already energy efficient. They can also buy and remodel an older home to be energy efficient and the costs of the updates will roll into the loan without the need for a bigger down payment.
An FHA Section 245(a) Loan is geared toward a borrower whose income will increase over time. With this loan, you will start with smaller monthly payments and then those payments go up over time. There are different plans available with different increasing payments amount. In order to find an FHA loan, you get it from FHA approved lenders. The FHA doesn’t give out loans and instead just insures them.
These loans are for veterans of the U.S. armed forces and occasionally their spouses to buy homes. Many of these loans don’t require a down payment since the Department of Veteran Affairs guarantees them.
VA Loans will usually offer the best terms and flexibility when it comes to the loan options offered to military buyers.
These different types of mortgages are backed by the U.S. Department of Agriculture and can help rural home buyers with low to moderate incomes qualify. Some of the USDA loan limits are based on the family size and local market conditions. Loans can be used for regular, modular. or manufactured homes that are no more than 2,000 square feet in size.
If you can’t afford a 20% down payment, you will have to get private mortgage insurance. People try to avoid paying for this insurance by getting a piggyback or combo loan. This means you take out two loans of any type at the same time.
With this type of mortgage, you only pay interest for a certain period of time and then the total principal amount will be due after this time period.
A jumbo mortgage refers to one that is too big for the federal government to guarantee. The limit is currently set at $700,000. This means that the borrower is likely not going to get the lower interest rates that are available on smaller loans. These loans are generally more common in higher-cost areas and do require more in-depth documentation to qualify.
A jumbo mortgage means that you can borrow more money to buy a home in an expensive area. The interest rates are still comparable with other types of loans. However, you will need a higher down payment and a high credit score. Many require a score of 700 or higher but you may qualify with a score of 660. You need to have a low debt-to-income ratio and you will need significant assets.
If you already have a mortgage and have some equity built up then you are able to take out a home equity loan or a second mortgage. This is another loan that is secured by the equity in the home. These loans can have a higher interest rate than your first mortgage but can be used for funding a home renovation and other necessary expenses. It can make sense to take out a second mortgage when there are low-interest rates available.
A subprime loan refers to a loan given to a borrower with a higher risk than those who are referred to as prime. These are bad credit mortgage loans. Prime borrowers offer the lowest risk. A prime borrower has a lower risk because he or she has a high credit score, low debt, and a good income. A subprime borrower can have characteristics such as a lower credit score, higher debt load, and lower-income. There are two different situations where borrowers can be considered subprime. Subprime borrowers will usually have no credit or poor credit.
A person with no credit has never borrowed money before. Borrowing money is the only way to build credit. Those with poor credit may have had problems with repaying debt in the past or have too many loans. Income may also be insufficient to cover any outstanding loans. Subprime loans will affect interest rates. A subprime rate is a higher interest rate for those with bad credit. If you are a bad credit borrower you can expect this.
Understanding Mortgage Terms
To understand the different types of mortgages, it also helps to have an understanding of the terms that come along with them. While there are many mortgage terms, there are some that will be used no matter what type of mortgages you seek.
This abbreviation stands for annual percentage rate and it’s the total effect cost of the extension of credit. This will include the loan interest rate and upfront cost.
This is the written estimate for the current market value of the property. A professional appraiser prepares it.
This is an optional prepaid charge that a borrower can pay in order to lower the interest rate on the loan. These points will affect the cost of the loan. A single point will equal one percent of the interest. These can also be referred to as discounts points.
This is the meeting at which the involved parties will sign the final loan documents. These documents include the deed, mortgage, statements, and more. The settlement agent, who is usually an attorney, will collect the buyer’s funds from them and pay the transaction fees, including approval fees and document recording fees. The agent will also pay the seller for the net proceeds of the sale. At the time of the closing, the purchase paperwork is recorded. During the closing, there will be closing costs. This is a catchall term that refers to the cost of servicing the loan. It can include the costs of processing and closing the loan. Some fees include attorney fees, credit report fees, termite inspections, and title insurance. The closing cost will apply whether or not a home was financed.
This is the process of either approving or denying a home loan based on the evaluation of the property and the ability of the borrower to pay back the loan.
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Qualifying For a Mortgage
Each of the different types of mortgages will have their own requirements for credit scores, debt-to-income ratio, qualifying income, and down payment requirements.
One of the biggest factors in determining whether or not you qualify for a mortgage will be your credit score. If you have good credit then you don’t really have to worry. However, if your credit isn’t that great then it can be more difficult to get approved for a home loan. There will be a set of minimum requirements for credit scores for each loan program. However, lenders don’t necessarily have to follow these requirements and can set their own credit score guidelines.
In order to qualify for a mortgage, not only are there requirements for a credit score but there are also income guidelines. To qualify, you will need to prove your income is consistent and sufficient. If you have a salary then this is easy. If you are self-employed or have a commission-based job, this can be more challenging. You will need to have at least two years of income documentation from the same employer or in the same industry. If you get commissions, you will need to average your income from the last two years of tax returns. Qualifying income can include your salary, income from part-time jobs, income from a second job, bonuses and overtime seasonal jobs, and child support and alimony.
If you want to find out for which loans you are qualified with your credit score, you can fill out the form below and see suggestions from Loanry.
In order to help with the qualification process, you need several documents. It will help to start getting these documents ready for the loan officer. These documents include W2 forms from the past two years, three months worth of pay stubs, bank statements for the last three months, the previous two years of tax returns, a list of assets and debts, and any additional income documentation.
Steps to Getting a Mortgage
With so many factors for qualifying for the different types of mortgages, there are some steps you can take in order to better qualify.
Repair Credit and Increase Your Score
Since the credit score is one of the most important factors, it helps to start paying attention to your score and work on increasing it. Different mortgage lenders require different credit scores but do not think about it. Just think about improving it as much as you can. Things you can do to improve your score quickly include paying down revolving debt, such as auto loans or credit card, using a debit card instead of credit cards for future purchases to stay out of debt, and paying bills on time. You should also correct any errors you see on your credit report.
When you are hoping to qualify for a mortgage, don’t open any new credit accounts. Applying for any new credit will temporarily lower your credit score. Lenders will be afraid that if you have a lot of available credit you will take advantage of it and then it can affect your ability to make your mortgage payments on time.
Get a Higher Paying Job
If your income is what is holding you back from getting a mortgage then you may need to find a higher paying job. Search for a new job in your existing line of work that will allow you to earn more money. Since lenders will want to see a steady employment history, you will need to stay in the same line of work in order to make this work. This can be hard for many borrowers since switching professions may give the best chances for a salary increase.
If switching companies isn’t enough to get you a raise, see what you can do to make yourself more valuable to employers. Is there continuing education you can complete? Getting a part-time job along with your full-time job may not provide what lenders can consider qualifying income. Lenders can view a part-time job as temporary and they want long-term income.
Save As much As You Can
No matter the different types of mortgages you are interested in, saving is important. During the time you are fixing credit scores, work on saving as much as possible. The larger your down payment, the smaller loan you will need. The lower loan-to-value ratio will mean that you are less risky to lenders. This can help you qualify for a better loan. While you may not need to save 20% for a down payment, the more you can put down, the better. If you aren’t using the money you have saved for a down payment, you can use it to make repairs for the home or to furnish it.
Don’t Pay More than the Appraised Value
The bank or a lender won’t lend you more than the property is worth because they will be on the losing end of the deal if you enter foreclosure. A 20% down payment isn’t as valuable if the home is worth 20% less than the purchase price. The collateral value is an important factor for lenders so you need to keep this in mind when making an offer to purchase a home.
To different lenders, what will constitute debt isn’t a set number. It’s a total monthly debt number that will be too high for you to be able to afford the monthly mortgage payments you want. When deciding how much of a loan you qualify for, lenders look at the front-end ratio. This is the percentage of your gross monthly income that the home payment takes up. The back-end ratio is the percentage of gross monthly income that will be taken up by other monthly obligations, such as car payments and credit card debt.
The more debt you will need to pay off each month will lower the monthly housing payment a lender will decide you can afford. It doesn’t matter if it is good debt, such as a student loan, or bad debt, such as a credit card. The lender just calculates the total debt number. If you want to be able to afford more home then you will need to decrease your debt.
There are many different types of mortgages that borrowers need to be aware of when deciding to purchase a home. Some mortgage types will determine how you pay your interest. They also determine how much interest you will be paying over the life of the loan. Other mortgage types make it easier for borrowers with poor credit scores.
In order to improve your credit score, it’s important to pay bills on time and reduce as much debt as you can. There are different mortgage terms you should learn in order to make mortgage loan shopping an easier process. Qualifying for the different types of mortgages will depend on the lender use choose. But it helps to reduce debt as much as possible, save as much as you can, and work to improve your credit score.
Jackie Strauss is a finance writer with a background in economics living in Los Angeles. She has a passion for helping readers learn more about personal finance, insurance, home loans and paying down debt. As a college student during the Great Recession, she has had to learn budgeting and money saving techniques to become a new homeowner.