Without the ability to purchase a home completely in cash, it’s necessary to obtain a home loan. Finding the best mortgage is crucial to ensuring your budget and home loan needs are met. Prior to choosing a mortgage, it’s first important to understand the key components of such a loan.
What Is Mortgage?
A mortgage is similar to any other type of loan in that you are establishing a legal agreement to borrow money from a lender and repay that loan with interest over a specified period of time. In the case of a mortgage, the loan is used for the purpose of purchasing a home.
Mortgages are comprised of two parts. The first part is the loan amount, known as the principal. The second part of the loan is the interest charged on the loan amount. Lenders charge interest on the loan as a fee for loaning you the money. The loan is repaid over time in installment payments. These payments are usually made on a monthly basis.
There are several different options of mortgages from which to choose when you are shopping around for a home loan. The different types of home loans are:
- Conventional home loan
- Conforming mortgage
- Nonconforming mortgage
- Federal Housing Administration (FHA) loan
- U.S. Department of Veterans Affairs loan (VA) loan
- U.S. Department of Agriculture loan
Understanding the Different Types of Mortgages
In choosing which type of mortgage loan is best for your needs, it’s important to be aware that not all loan types are the same. Some mortgage loans have stricter guidelines than other types of loans. For example, while some loans require borrowers to have excellent credit, other loans might require a minimum down payment of 20 percent. Other types of home loans are designed to serve the needs of first-time home borrowers.
A common misconception is that the U.S. government makes loans. This is not the case; however, the government will guarantee some types of loans that meet certain requirements regarding loan limits and income.
The federal government does not back or guarantee conventional loans. This type of loan is best suited for borrowers with steady employment and good credit. In most cases, a minimum down payment of three percent is required for a conventional loan. The caveat to such a low down payment is that you will need to pay private mortgage insurance or PMI. To avoid the need for private mortgage insurance, you will need to make a down payment of at least 20 percent.
Conforming Mortgage Loans
A conforming mortgage loan features maximum loan limits. Those limits are established by the federal government and typically vary among geographic areas. For instance, a high-cost area will usually have higher baseline loan limits for conforming mortgage loans.
Nonconforming Mortgage Loans
To qualify for a nonconforming mortgage loan, you may be required to have a larger down payment than usual. This is due to the fact that the loan limits for nonconforming mortgage loans may exceed the limits of conforming loans. For this reason, these loans are often referred to as jumbo loans.
Borrowers purchasing a home for the first time may find that a loan insured by FHA is a good option for them, especially if they do not meet the lending requirements for a conventional home loan. Among the benefits of this type of loan is a down payment as little as 3.5 percent of the total purchase price. The credit score requirements for this type of loan are also usually less stringent. The downside to an FHA loan is the requirement for borrowers to pay a form of mortgage insurance known as mortgage insurance premium. This fee is paid upfront as well as annually until the loan is completely repaid. Even so, this may be a good option for borrowers who do not have the cash reserves to make a large down payment or who would not be able to qualify for a conventional home loan.
Qualified military service members and veterans may wish to consider a home loan guaranteed by the U.S. Department of Veterans Affairs. There is no down payment requirement for this type of loan. Additional benefits of a VA loan include a limit on closing costs and no mortgage insurance premium. There are also no broker fees. A funding fee is required with a VA loan, which takes the form of a percentage of the total loan. This fee is based on the loan amount as well as the borrower’s military service category.
Borrowers living in rural areas may wish to consider a USDA loan. The benefit of this type of loan is low down payment. Some borrowers may even qualify for a USDA loan with no down payment.
Once you understand a bit about the different types of home loans, the next step is to find a lender. The steps below can help you to find the best lender for your specific needs.
Review Your Credit Score
One of the more common reasons for borrowers to be turned down for a home loan is a low credit score. Lenders typically require a minimum credit score to approve a mortgage loan application. Borrowers with low credit scores are typically seen as being a greater risk to lenders. Conversely, the higher your credit score, the more likely you are to be approved for a home loan. Additionally, you may be able to qualify for a lower interest rate if you have a higher credit score.
The first step to raising your credit score is to review your credit reports and ensure they contain no errors. You will need to review your credit report from all three credit reporting bureaus. They are TransUnion, Experian, and Equifax. According to law, the bureaus are required to issue you, upon request, a free copy of your report once per year.
Another way to raise your credit score is to pay off as much of your high-interest debt as you can. Additionally, work on reducing the overall amount of your debt. The less debt you have reflected on your credit report, the more likely you will be approved for a home loan, as lenders carefully consider your debt-to-income ratio when making a lending decision.
Educate Yourself about Current Lending Options
Many people make the mistake of thinking their only options for obtaining a home loan are their local banks. This is certainly not the case. In fact, you have many other options, including credit unions, mortgage bankers, savings and loans, mutual savings banks. Spending some time getting to know each lending option to discover which might be the best for your specific lending needs.
Get a Pre-approval
Prior to shopping around for a home, it’s important that you obtain a pre-approval from a lender. This can be particularly important if you find yourself in a situation in which you are bidding against other buyers on the same property. If a seller has a choice between accepting an offer from a bidder who does not have their lending in place compared to a buyer who does, they are more likely to accept the bid from the pre-approved buyer, even if that bid is actually lower.
To obtain a pre-approval letter from a mortgage lender, you will need to provide the lender with information to evaluate your finances. This will give the lender the opportunity to assess how much money you can reasonably borrow, which will determine how much home you can afford to buy.
Additionally, getting pre-approved for a loan will help you to save quite a bit of time, as the lender will not have to wait for you to supply information in order for your home loan to be processed.
Among the information you will need to supply to get pre-approved, includes:
- Banking account information
- Social Security number
- Debt obligation information
- Tax return information for two years
- Employer and salary information
- Down payment information
Ideally, it’s best to go ahead and get pre-approval letters from several lenders. This will give you the opportunity to compare loan terms.
Compare Mortgage Rates
The interest rate you pay on your home loan can make a significant impact on both your monthly mortgage payment as well as the total cost of your loan. For this reason, it’s important to look around and find the best possible rates. In order to provide you with interest rate information, lenders will need to review your credit information. Once you are satisfied with the information provided, you will have the opportunity to lock in that rate for a period of time. This is a step that certainly should not be overlooked, as a low-interest rate could potentially shave several thousand dollars off the total cost of your loan.
Always Read the Fine Print
Finding a lender is one of the most important steps you will take in your financial life. Due to that importance, you might consider asking friends and family members for lender referrals. Online reviews can also help to provide guidance when locating reputable lenders. After you have identified a few lenders, the next step is to dig a little deeper and ask some questions.
For instance, find out how the lender prefers to communicate. Do they tend to communicate with clients via email, phone, or text? Additionally, how quickly is the lender able to respond to questions?
Find out what kind of turnaround time you can expect on a loan preapproval as well as the appraisal and closing process. While there are often unexpected delays in the lending process, you should still have an idea of what to expect in terms of a timeline.
How much should you anticipate paying in lender fees? Such fees may include loan origination, commission fees, appraisal fees, points, application fees, and fees for credit reports. Additionally, don’t forget to ask whether the lender will be able to waive any of these fees or whether it might be possible to roll some or all of the fees directly into your loan. Rolling fees into the loan will reduce the amount of money you need to come up with out-of-pocket at the loan closing, but it will increase the total amount of your loan. Naturally, this would also potentially increase your monthly payments.
What is the minimum down payment requirement for the loan you are considering? The last thing that you want is to discover at the last minute that you need a larger down payment than you had anticipated
Keep in mind that if there is anything you are not sure about regarding the loan, do not hesitate to ask for a more detailed explanation. Take the time to read through the fine print of all documents related to your loan. The loan documents will provide such information as finance terms, any contingency information, who is responsible for paying which closing costs, and the closing date. If there is anything you are unsure about or do not understand in the loan documents, consider having an attorney review the information with you.
Purchasing a home is an important life step. Following the home loan tips listed above can help you to make the most of this opportunity and ensure you find the right home loan to suit your needs.