If you think you are ready to become a homeowner, you need to consider the many financing options available before diving into the home search.
Financing a home purchase is more than just getting a bank to offer you a loan, as you do not want to find yourself in a sticky situation simply because you jumped too quickly into buying a home before you truly understood everything that comes with that financial investment.
Financing a home typically means getting a mortgage backed by a bank or other financial institution serving as a lender. Lenders will evaluate your suitability as a borrower and offer you pre-approval on a specific loan amount so that you can search for a home under that amount. That pre-approval is not an absolute final number; there are complications that can alter your loan amount that you should understand ahead of time. Let us go through the different types of mortgages you might have available to you, plus any other financing opportunities, especially for first-time buyers.
A mortgage is essentially a real estate loan, sometimes called a home loan or a property loan. A lender will evaluate your financial situation in order to calculate your potential ability to repay it, which will help you to figure out your price range for new homes.
If you are pre-approved for a loan, you can begin your home search in earnest, knowing that a lender is willing to loan you that amount. Keep in mind, however, that certain circumstances might affect that pre-approval. After you are pre-approved and before you close on a new home, make sure not to open any new lines of credit, such as getting a new car loan or signing up for a new credit card, since that can affect your mortgage availability.
Another way your pre-approval amount could change is if your appraisal comes back much lower than the purchase price listed. If this happens while you are under contract, you still have options. You could choose to walk away from the deal, to renegotiate with the seller or you could choose to pay the difference as your down payment since your lender will undoubtedly lower your approval.
You certainly are not expected to purchase a home in full in cash up front. Of course, some people are able to do just that, especially after selling a previous home. However, there are considerations for buying a home outright as well, including tax implications. If you are in a position to avoid a mortgage altogether, first review your financial situation with a professional to ensure you make the best choice based on your circumstances.
Mortgages are typically offered as either fixed-rate or variable-rate (or adjustable-rate mortgage, sometimes called ARM) and are most often offered on a standard 15-year or 30-year timeframe. You might also be able to get a 10- or 20-year mortgage from certain lenders. These options offer you the chance to choose a combination of factors that best suits you and your circumstances.
If you are buying a forever home and intend to stay in it for thirty years or more, then taking advantage of a fixed-rate 30-year mortgage can keep your monthly costs as low as possible while also ensuring your rates do not jump up at all during the course of your repayments. If, however, you plan to move again in a few years, then you might want to opt for a variable-rate mortgage if the rate is currently low. Taking advantage of those low rates while they are available can pay off in the end, as long as you do in fact move again and you therefore do not risk rates jumping up while you still own and owe a large amount.
These fixed- or variable-rate mortgages refer to the rates of interest charged. The mortgage amount you get approved for at the time of purchase is for the cost of the home you want to buy; however, the actual amount you pay will also include the interest spread over the years it takes to repay the mortgage.
Financial institutions like banks offer mortgages, and these mortgages are considered conventional loans. These are offered by private institutions and are not backed by government agencies. Conventional loans can be called conforming or non-conforming; conforming conventional loans adhere to requirements from Fannie Mae and Freddie Mac, which are two government-supported organizations that buy mortgages and sell them to investors.
Government loans can come from different sources, the most popular being an FHA (Federal Housing Administration) loan. FHA loans are particularly popular among first-time homebuyers because they allow a borrower to put down a low percentage down payment and also grant loans to a wider variety of borrowers. However, FHA loans do require you to pay for mortgage insurance, which includes a premium to be paid up front plus an annual premium, so be sure to add that to your costs when calculating your total home financing. However, many FHA loan borrowers get some of their closing costs covered, so that can help at the time of purchase.
If your credit score is not great, you might still qualify for an FHA loan where you wouldn’t qualify for a conventional loan. If you do qualify, you must use an FHA-approved lender for this particular mortgage. Other government loans include USDA (U.S. Department of Agriculture) and VA (Veterans Affairs) loans, both of which suit particular groups but offer great opportunities if you meet their qualifications (including no down payment necessary). The U.S. Department of Housing and Urban Development (HUD) also offers the Good Neighbor Next Door program for qualified firefighters, police officers, emergency personnel and teachers of kindergarten through high school.
Fannie Mae and Freddie Mac are the two government-sponsored loan options that offer low down payment percentage options and competitive rates. As mentioned previously, they buy mortgages and sell them to investors in an effort to make mortgages more widely available. It is always a good idea to research locally in case there are options within your community or state for other grants or loans. You never know what you might find that could help you to get your dream home.
An important consideration when looking at your financing options is the amount you can pay for a down payment. Some first-time homebuyers and other qualified buyers might be able to put down as low as 3 to 5 percent for a down payment.
However, putting down such a small percentage means your lender will very likely require you to buy mortgage insurance. Private Mortgage Insurance (PMI) is an additional cost that will be required at closing, before you complete your new home purchase.
In addition to the insurance you might need to add, keep in mind the many other costs included with your home purchase, from the monthly mortgage payment that includes interest to the closing costs, homeowners insurance, HOA (homeowners’ association) fees, regular maintenance costs, random repair costs and more. Be careful not to evaluate your ability to buy a house solely based on the amount your bank says you can qualify for with a mortgage. Consider the many other costs to make sure you put yourself in a good position to maintain your homeownership status.