So you want to buy a new home? Unless you have the cash to entirely finance the purchase, you’ll need to get a mortgage – a legal contract that pledges a property as security for a loan.
The property is basically the collateral for the mortgage that you take out. If you don’t make payments as agreed in the mortgage contract, the lender can take possession of your home through the process of foreclosure.
Since the cost of a home can run into hundreds of thousands of dollars, a mortgage loan tends to be for a very large sum of money, which you get to pay off over a long period of time – usually around 15 to 30 years.
You can obtain a mortgage from a bank, a mortgage broker or wholesale lender. Since a mortgage represents a hefty investment on your part, and there are many kinds from which to choose, it’s wise to be diligent in your research and selection of a particular mortgage loan.
Be absolutely sure that it is well suited to your needs, and that you can afford to pay it for as long as you plan to remain in the home.
To help you get started, here’s a rundown on the different types of mortgages available, courtesy of MortgageLinks.org and Homestore.com, two online informational resources on home buying and mortgage loans.
Most common mortages
• Fixed Rate (FRM): the mortgage-payment rate and loan payments remain fixed for the life of the loan, usually 30 years. Shorter term fixed rates (usually 15 or 20 years) carry lower interest rates, higher payments, and less money paid out than with longer term loan mortgages. Longer term fixed rates have smaller monthly payments and are easier to budget than shorter term mortgage loans.
• Adjustable Rate (ARM): interest rates start lower than with a fixed-rate mortgage, but then become variable.
At specific intervals (typically every year), a lender adjusts the rate up or down as interest rates fluctuate. Its lower initial rate can help you qualify for a larger mortgage loan.
As long as you know your income will rise to keep pace with an ARM’s periodic adjustment, and if you plan to move in a few years, an ARM could be a good choice.
Other, less common, mortages
Although the majority of buyers will go with the standard fixed-rate or adjustable-rate mortgages, there are other types of mortgages that are available to finance the purchase of real estate:
• Balloon loans give borrowers lower rates and payments for a specific period of time – anywhere from three to 10 years.
After that point, the borrower has to pay off the principal (amount borrowed) balance in a lump sum.
Under certain conditions, they can be converted to fixed-rate or adjustable-rate loans. Many borrowers either sell their homes before they get to their due dates, or end up refinancing their balances into new mortgages.
This is a great mortgage option for buyers who don’t plan on living in the property for long. A disadvantage is that if your plans change and you decide to remain in your home, you will have to pay off your mortgage, or refinance the balance, which will result in additional closing costs.
• Jumbo loans are considered as non-conforming loans because they exceed the loan limit set by Fannie Mae and Freddie Mac (the two publicly chartered corporations that buy mortgage loans from lenders), thereby ensuring that mortgage money is available at all times in all locations around the country.
If you require more money in your loan, then a jumbo mortgage may be a good option. You’ll have the opportunity to purchase larger, more expensive properties, but you’ll also be paying a higher interest rate in exchange for the lender’s higher risk.
• Subprime loans are reserved for individuals with less-than-satisfactory credit, based on their FICO scores (FICO scores are a number assigned to you based on your credit rating).
These mortgage loans have higher interest rates and more burdensome terms than conventional loans, but they give bruised-credit borrowers a chance to reap the benefits of home ownership just like their more creditworthy cousins.
Be prepared for inconsistent terms because interest rates, fees, and underwriting guidelines can vary drastically among lenders.
• Assumable loan are relatively rare, but a homeowner with an assumable loan can “hand off” the loan to a buyer instead of paying it off using proceeds from the home sale.
If rates are low and you can get one, by all means, do so. If rates rise, buyers will be able to assume your loan at the rate you currently pay (and will be willing to pay more for your house) because it will be much cheaper than any loan they could get from a bank or other source.
An advantage of an assumable mortgage is that it reduces monthly payments and saves money on closing costs. A disadvantage is that sellers will charge more for their property, so buyers need more cash to cover the difference between the asking price and the loan balance.
• Two-step loans combine elements of fixed and adjustable-rate mortgages. Features a fixed rate and payment for an initial period, followed by one adjustment, then a fixed rate and payment for the remainder of the loan term.
These mortgages will have names such as 2/28, 5/25 or 7/23. A 7/23 mortgage, for example, has an initial fixed period of seven years, an adjustment, and then 23 more years of payments following the adjustment.
These types of mortgages give borrowers with damaged credit an opportunity to buy a home and to establish better credit. However, if your credit does not improve, you could be stuck in a high-rate loan for much longer than two or three years.
• Biweekly loans are a fixed-rate mortgage in which payments are made every other week instead of monthly.
It is a method used to shorten the life of a 30-year mortgage simply by dividing what would be your monthly payment into two.
This means you will be paying 26 “half-payments” a year (the equivalent of 13 monthly payments), with the 13th monthly payment being applied entirely to the balance of the principal.
By making more payments, you’ll have a dramatic impact on the length of the loan. For example, a 30-year loan can be paid off in about 23 years through this method.
The only tricky part of changing to a biweekly mortgage is in making sure your lender accepts your payments and correctly credits the extra portion to the principal.
Besides cutting your mortgage short, biweekly payments could serve as a good budgeting tool for many people, although it is not recommended for people who may encounter financial problems since these payments are made so close together.
• Federal Housing Administration (FHA) loans help eligible buyers to qualify for a down payment (as low as three percent). Loans come from lenders approved by the U.S. Department of Housing and Urban Development (HUD).
• VA loans are administered by the Department of Veterans Affairs and help eligible veterans and service personnel to get loans through conventional lenders. Down payments may not be required.
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