Whether you're a first-time or experienced homebuyer, figuring out how to finance your dream home is one of the most important decisions you'll make. That's why, with the help of Don Fowler, Sr. Loan Officer at Movement Mortgage,we've put together this Mortgage 101 primer. Our goal is to help you navigate the often complex world of home financing with ease and confidence as we dive into mortgages for beginners. Let's get started!
The Basics of Home Financing
Before we walk through the different types of mortgage loans available, it's important to have a general understanding of some of the basic home financing terms.
What is a mortgage?
Buying a home is likely the biggest purchase you'll ever make. Thankfully though, you don't have to pay the entire amount upfront. Instead, you can get a home loan, known as a mortgage, from a bank or other financial institution.
Don explains that a mortgage is an agreement between a borrower and a lender. It allows you to borrow money to buy a home. You'll put down a certain amount of money upfront (the down payment), and the bank will cover the rest. Then, you pay back the loan over a set period with interest. If you fail to repay the loan, the mortgage lender has the right to take or foreclose on your home.
According to the Consumer Financial Protection Bureau, most homebuyers opt for a 30-year mortgage. But, there are loans with shorter terms available like 10, 15, or 20 years. The longer the term of the loan, the lower your monthly payments will be. You will though end up paying more in interest over time1.
Mortgage Insurance Explained
Mortgage insurance, Don notes, insures the difference between your down payment and the amount of the loan. It's a mechanism to protect the lender if you don't make the payments on your loan or if the value of the house goes down. Mortgage insurance premiums are usually added to your monthly mortgage payment but can also be included with closing costs as well.
Understanding Your Credit Score
Your credit score is a three-digit number that lenders use to assess your creditworthiness. A higher score means you're less risky to lenders, which can help you qualify for better loan terms. Credit scores typically range from 300 to 850, with 850 being the highest possible score. The score is calculated using various factors. These include your payment history, credit utilization, length of credit history, types of credit accounts, and new credit applications.
To maintain a good credit score, it's important to pay all bills on time, keep your use of credit low, and regularly check your credit report for errors or suspicious activity. If you have a low credit score, you can work to improve it by paying off debts, disputing any errors on your credit report, and building a positive credit history over time.
What is a down payment?
The down payment is a percentage of the home price you pay upfront. Don says that the down payment for a home is typically between 3% and 20% of the purchase price. For example, if the home you want to purchase costs $300,000 and you want to put down 20%, your down payment would be $60,000.
Most Common Types of Mortgages for Financing a Home
There's more than one way to finance a home. Don walks us through some of the most common conventional and government-backed types of mortgages.
Conventional loan options
A conventional mortgage is any type of mortgage loan that is not insured or guaranteed by the government. According to Don, there are three primary types of conventional loans that you can use to buy a home.
1. Fixed-Rate Mortgage.
With a fixed-rate loan, your mortgage interest rate (and thus your monthly payment) stays the same for the life of the loan. These types of loans are best if you plan on staying in your home for a long time and prefer the stability of knowing exactly what your payment will be each month. A fixed-rate loan is backed by Fannie Mae or Freddie Mac, which buy loans from approved lenders. Those lenders are then able to use that money to offer mortgage loans to more people2.
2. Adjustable-Rate Mortgage (ARM).
With an adjustable-rate mortgage, your interest rate can change over time. Initially, ARMs typically offer lower interest rates than fixed-rate mortgages. After a certain period, the rate can go up or down based on market conditions. Adjustable rate loans are a good option if you're only going to be in the house for a short time.
3. Jumbo Loan.
A jumbo mortgage is a loan where the amount is higher than that allowed by the Federal Housing Finance Agency (FHFA). The FHFA is responsible for the supervision and oversight of Fannie Mae or Freddie Mac. These entities do not back jumbo loans. Don says that the threshold for a loan to become jumbo varies from state to state. However, in most parts of the country, the threshold for 2023 is a loan amount of $726,200. He further emphasizes that lenders underwrite jumbo loans more stringently and often require more documentation.
All three of these types of home loans require a down payment and/or a higher credit score. Don notes that with our current interest rates, "The only thing that makes sense right now is a 30-year mortgage.
If you don't pay at least 20% of a conventional loan as a down payment, private mortgage insurance (PMI) will be required.
Government-Backed Mortgage Loans
Government-supported loans are backed by government agencies. These loans often have more flexible eligibility requirements. They can also be a good option for first-time homebuyers or those who don't have a large down payment saved up. Here's a look at the three different types of government-backed loans.
1. Federal Housing Administration (FHA) loans.
The FHA is one of the largest mortgage insurers in the world3. Having your loan insured by the Federal Housing Administration enables lenders to offer you a better deal. That means your down payment could be as low as 3.5%4, which is lower than most loans.
"These loans help those lacking down payment funds or with lower credit scores," says Don. "Especially in this market, they get a much better interest rate with a lower credit score than they would through a conventional loan." Movement Mortgage currently offers a product called FHA Boost where they provide support for the down payment and up to 1.5% of the loan for closing costs in the form of a 10-year loan.
While FHA loans don't require PMI, they do require mortgage insurance premiums MIP7.
2. Veteran Affairs (VA) loans.
To qualify for a VA loan, you must be a veteran, service member, or eligible surviving spouse. Private lenders provide them, and the VA guarantees a portion of the loan5. According to Don, most VA loans can be 100%. No down payment or mortgage insurance is required.
3. U.S. Department of Agriculture (USDA) loans.
USDA loans help low- to moderate-income homebuyers purchase houses in eligible rural areas6. Just like VA loans, this type of loan typically doesn't require a down payment. It also doesn't have any mortgage insurance requirements.
Other Less Common Types of Loans to Finance a Home
In addition to conventional and government-backed loans, Don says there are a couple of other less common types worth mentioning.
1. Bank statement loans.
These are good for self-employed people. They may turn over a lot of income, but their tax return may not show a lot of net income. Lenders can look at 12 or 24 months of their personal or business bank statements. Based on those, the lenders can come up with an income to see what the homebuyer can qualify for.
2. Debt service coverage ration loans (DSCR).
Real estate investors are the target market for DSCR loans. They must show proof that rent from the home they're purchasing can cover the mortgage. If that's not the case, a DSCR loan is still possible, but the lender will require a larger down payment.
Different Types of Lenders
Don explains that three key entities do mortgage loans.
- Banks. These financial institutions offer a wide range of loan products. They use their own funds to lend money to borrowers and usually require very solid credit and financial histories before approving a mortgage loan.
- Independent mortgage lenders. On the other hand, independent mortgage lenders, like Movement Mortgage, specialize only in mortgage lending. They usually have more flexible lending guidelines than banks and can offer more loan options. Independent mortgage lenders loan their own money and service the loans like a bank does.
- Brokers. They act as intermediaries between borrowers and lenders and work to find the best mortgage option for their clients. Brokers receive a commission from the lender or borrower for their services. They do not use their own funds to lend money. Instead, they help borrowers find the best lender and loan product for their needs.
Overall, each entity in mortgage lending has its advantages and disadvantages. You should go ahead and research your options and choose the best one for your specific situation. To learn about our preferred lenders, be sure to sign up for our West & Woodall Homeowner Resources Guide.
Pre-Approval and Shopping for a Loan
Before you begin looking to buy a home, it's a good idea to get pre-approved or find out how much you can qualify for a mortgage. This shows sellers that you're a serious buyer. It also gives you an idea of how much you can afford to borrow. When shopping for a mortgage, don't just consider the interest rate. Look at the annual percentage rate (APR), which includes the interest rate and other fees, to better understand the loan's true cost.
Closing the Deal
Once your offer on a home is accepted, you'll enter the closing process. This involves lots of paperwork, but the key part is the closing disclosure. This document outlines your mortgage's final terms and costs, so read it carefully.
How to ask us a question
Our agents or other trusted local experts answer your questions every month through the Ask a REALTOR® series. If you have a real estate question that you want answered, we’d love to hear from you at marketing@westandwoodall.com.
Sources
- Consumer Financial Protection Bureau. Understand Loan Options.
- Fannie Mae. What We Do.
- Federal Housing Administration. About Us.
- Federal Housing Administration. Let FHA Loans Help You.
- U.S. Department of Veterans Affairs. VA Home Loans.
- U.S Department of Agriculture. Single Family Housing Programs.
- FHA.com.