Understanding your mortgage options
Buying a home is a big deal. There are tons of decisions that go into the purchase. Getting the mortgage is probably the least exciting piece of the puzzle and can often be the most stressful. It is important to understand how to deal with lenders to ensure a smooth process. Interest rates have been below 5% for years now. This makes it easy to choose a 30 year fixed rate mortgage for most situations. If rates move up then it could be time to look at some other options. Below is a breakdown of different products:
Types of Mortgage Loans
1. Fixed rate mortgages - The interest rate and payment amount are fixed for the entire duration of the loan. Most common Types:
30 year fixed rate: The loan will be paid off in full at the end of the 30 year term.
15 year fixed rate: Rate is lower than a 30 year term. The loan is paid in full after 180 monthly payments. The payments are obviously higher than a 30 year because the loan is paid off in half the time.
2. Adjustable rate mortgages - The interest rate will change or "adjust" at specific intervals. Typically the rate will be fixed for a set number of years and then adjust annually. Interest rates are usually initially lower than fixed rates, but there is the risk that they may rise in the future causing an increase in your monthly payment. Most common Types:
3/1, 5/1 or 7/1 ARM: These are adjustable rate mortgage options. A 3/1 ARM means the rate is fixed for the first 3 years and then adjusts every 1 year after. So the first number represents how many years the loan is fixed and the second number represents how often the rate adjusts. The 5/1 is fixed the first 5 years and then adjusts every year after.
Conventional Loan :
A conventional loan simply means it is a loan that is not backed by a government agency. These types of "regular" loans are offered at banks, credit unions, and other lending institutions. The mortgage is typically underwritten according to Fannie Mae and Freddie Mac guidelines so they can be sold in the secondary market.
FHA Loan :
FHA stands for Federal Housing Administration. FHA loans are available to all types of buyers, not just first-time homeowners and are backed by the federal government. They can be a great option if you have do not have great credit or you don't have enough for a typical 20% downpayment. There are additional costs you are responsible for with FHA loans. The government requires two different types of mortgage insurance premiums to be paid in order to protect the lender in case of a default. This Investopedia link explains the program much better than I can.
Here is a link to a guide from Bankrate.com discussing the tightening of FHA loans during the pandemic along with ways to navigate obtaining a loan or how to apply for forbearance.
VA Loan :
VA loans are offered through the Department of Veteran Affairs for military service members and their families. VA loans are also guaranteed by the federal government and can be a great way to purchase a home. VA loans can offer homebuyers 100% financing without paying private mortgage insurance. Once again I will refer you over to Investopedia for all the details if you would like to learn more.
Check your credit report and score on a free site like Credit Karma before you apply for a mortgage. This will not count as an inquiry or negatively affect your score.
Choose carefully which loan officer you decide to work with. They can make or break your entire experience. Make sure to get referrals from people that have successfully used the bank and loan officer before.
Be prepared to provide current paystubs, two years of tax returns(not always), two months of statements for checking, savings, retirement, and investment accounts.
Once you submit your mortgage application do not make any big financial transactions. Do not lease a car, deposit $10,000 into your bank account, apply for a credit card, or co-sign a loan for your friend.
PMI stands for Private Mortgage Insurance. Lenders will require you to pay PMI if you put less than 20% down on the purchase. Paying PMI is like flushing cash down the toilet. You receive zero benefits. It protects the lender if you were to default on the loan.
Saving up to put 20% down on your home is generally a very good idea. You do not want to squeeze every resource available to purchase a home. It could end up being your biggest regret.
Change in Mindset
There are two different ways you can look at mortgages. The first way (which is the way most people feel) is that mortgages are a financial burden. The only mortgage they have is on the home they live in and they can not wait until the day it is paid off.
The second way is to look at mortgages (how real estate investors view them) as vehicles to become wealthy. Real estate investors want as many mortgages as possible as long as they are being paid each month by the tenant that is currently renting the home.
Try to wrap your head around this concept. Let's say you can borrow one million dollars on a 30 year fixed rate mortgage to purchase a 4 unit rental property. The rent from the 4 units covers all the expenses on the property including the mortgage, taxes, insurance, maintenance and a property manager plus it puts a few hundred dollars a month in your pocket. At the end of 30 years, the mortgage will be gone. The tenants would have paid off the entire mortgage. You would be left with a million dollar home (plus appreciation over 30 years) and no mortgage. All you had to do was borrow the money from the bank and let the tenants pay the bank back. 30 years later you are a millionaire. This would never be possible if you didn't take out the mortgage from the bank.