While finding the financing package that best suits your needs can be a complicated process, your REALTOR® can help you find the financing method that works for you.
Home financing is available from mortgage companies, savings and loan associations, banks, credit unions and others. Each will have its own rules, rates and fees. When you compare financial institutions, be sure to look for variations in the way mortgages are offered — distinctions that can mean dollars of difference to you. You will want to research the various lenders in your area to see which best fits your financial situation.
The number and variety of financing options can seem overwhelming at first, but most fit in one of these main categories. We review some of the different types of loans below.
Conventional Financing: Conventional mortgages are labeled as such to differentiate them from government-backed loans, such as FHA or VA loans.
Federal Government Programs: Programs sponsored by the Federal Government through the Federal Housing Authority, Veterans Administration or Farmers Home Administration.
Alternative Financing: Various alternative arrangements for home financing made by the buyer that can incorporate elements of Conventional financing programs.
Remember that financing options are affected by local and regional real estate and banking practices and in some areas by local and state law.
Questions to ask the lender
Before you make your home financing decision, you should be familiar with your options. Questions you should ask of your lender include:
- What are the differences between the various types of adjustable-rate loans and fixed rate loans?
- Is the mortgage open-ended? Can you borrow up to the amount of principal you’ve paid to make home improvements?
- Will mortgage insurance be required for loans other than FHA-insured or VA guaranteed mortgages?
- How much principal must be paid before the insurance requirement is dropped? What are the premiums and are the premiums refundable if you prepay the mortgage?
- What reserves, such as those for property taxes or hazard insurance, are required? How long must you pay into these reserves? At some point, will you pay these costs directly?
- What fees will be charged at closing, including such things as points, loan origination, abstracts, attorney’s fees, appraisals, termite inspection reports or credit reports?
Conventional fixed-rate mortgages: This traditional, “tried and true” mortgage option is a loan with a constant interest rate and level, equal payments during a set period of time — most commonly, 30 years. The biggest selling point of fixed-rate loans is predictability, and they are particularly suited to people with steady incomes.
Adjustable-rate mortgages (ARMs): As the name implies, the interest rate on an adjustable-rate mortgage changes throughout the term to stay current with the present interest rates. ARMs are most popular when rates are relatively high and appear to be dropping and when the difference between the ARM and the fixed-rate is greater than 2 to 3 percent. Different lenders offer variations in the front end of their ARM plans, such as the points you pay or discounted initial rates.
To make a useful comparison of an ARM rate, consider the index upon which the rate is based, the margin or spread between that index and the rate paid, and the intervals at which the rate and payments are adjusted.
Note: Always look at the index plus the margin when comparing ARMs. The larger the margin, the less likely the rate you pay will go down, even if the interest rates drop.
Jumbo loans for bigger homes: Mortgages are called jumbo when they exceed the maximum limit set by the Federal National Mortgage Association (FNMA, or “Fannie Mae”) and the Federal Home Loan Mortgage Corporation (FHLMC, or “Freddie Mac”), the largest national investors in mortgages. Currently, this limit is $300,700.
Because of the greater risk to the lender by the higher-than-average loan amount, some lenders charge slightly higher interest rates for loans in the jumbo category.
Balloon mortgages: Balloon mortgages are fixed-rate loans. Although based on a longer term, the mortgage must be paid in full with a balloon payment, usually in five to seven years. The advantage is that interest rates are generally set well below current market rates. Many borrowers of balloon mortgages refinance their loan before the balloon payment is due.
Two-step loans: Two-steps are adjustable rate mortgages that have only one adjustment during the loan term. They let you take advantage of the reduced start rate of an ARM while still enjoying the security of a fixed rate for some time.
Because the adjustment does not usually occur until several years into the loan term, two-step loans are particularly attractive to buyers who do not plan to stay in their new home more than a few years.
Federal government programs:
Federal Housing Administration (FHA) insured loans: Lenders offer FHA mortgages on a new or existing single-family home for as little as 3 percent down. FHA mortgages are also assumable. Sometimes a premium is required when the mortgage is assumed, then refunded when the note is paid off. Down payments are usually low.
Veterans Administration (VA) guaranteed loans: The Veterans Administration guarantees lenders against loss if a property is foreclosed due to default. These assumable loans are available to eligible veterans and may be used to buy, refinance, construct or repair a house. If the VA property appraisal is less than the sale price, the borrower pays the difference as a down payment.
Farmers Home Administration (FmHA) loans: The government makes these loans available to persons of moderate to very low income in rural or non-metropolitan areas.
Lease/purchase agreements: Borrowers can lock in the price of a house today and postpone financing for 12 to 18 months with these agreements. The borrower gives the seller a deposit which is applied to the purchase and makes monthly rental payments. Lease/purchase agreements are used by sellers who want to keep a home occupied and receive rental money after they’ve moved out, and by buyers who are not in a position to commit to a property at a particular time.
Installment contract: Buyers and sellers work out a contract which states a down payment, interest rate and term. Some contracts have long terms; others are short-term with balloon payments. Regulations about title transfer in a contract sale vary from state to state.
First mortgages from relatives or others: Sometimes relatives or private investors will purchase a home outright then offer a borrower a first mortgage. The terms are worked out to the mutual satisfaction of both parties.
Note: The Internal Revenue Service may impute higher rates on the lender for loans arranged below market rates.
Second mortgages: These are used when a borrower needs additional financing to buy a home. This mortgage may be financed by the seller, another lender, relative or investor, and terms are negotiated between buyer and lender. Often, second mortgages are used when a borrower assumes a guaranteed first mortgage with a lower interest rate and needs to make up the difference between the loan and the sale price.
Equity financing: An equity plan allows buyers to buy new homes by borrowing against a portion of the equity in their present home. A six-month “bridge” is secured on which no monthly payments are required and that money is used to purchase the new home. When the present home sells, the loan is paid off with the proceeds of the sale. If the home doesn’t sell within six months, the owner may renew the loan or choose from other “back-up” options.
Depending upon your situation, there may be other Financing Options available. You should rely on the expertise of your REALTOR® and Loan Officer during the critical final stages of the home buying process. He or she can answer questions, serve as your representative, and attend to the important details that affect your purchase.
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DISCLAIMER: This information is provided for general awareness only and is not intended for the purpose of providing legal, accounting, tax advice or consulting of any kind. Please consult with a professional in their respective expertise for complete details.