Unless you have hundreds of thousands of dollars saved up in the bank, odds are, you’re going to have to look into getting a mortgage before you can purchase your dream home.
But… what is a mortgage? And how do you get one? Don’t worry, you’re not alone. Today, we’ll go over the basics of mortgage 101 and hopefully by the end, you’d have learned a bit more about how to get the perfect mortgage for you.
First of all, what is a mortgage? A mortgage is a legal agreement where a lender lends money at interest to a borrower. In exchange, the borrower’s real estate or property is used as a collateral by the lender should the borrower default on payments. The process in which the lender takes ownership of the borrower’s property if they default is called foreclosure. The lender’s hold over a borrower’s real estate or property ends once the borrower completes paying off the loan.
There are many different lenders that deal in home loans. It’s important to research the different types of lenders you may encounter in order to get the best deal. Examples of lenders include retail banks, mortgage banks, etc. Another option is to work directly with a mortgage broker or an indirect lender who will act on your behalf to find the best loan for you, for a fee. Be careful when working with a mortgage broker as they may have particular lenders they work with and may not find you the best deal. Therefore it is best to check with two to three brokers to ensure you’re getting the best deal.
So what types of mortgages are there? Well, to start off, there are two main types of mortgages:
- Government-Backed Loans: Also known as a non-conventional loans, these are mortgages that are insured by the government (meaning the government will cover the losses for a lender if you default on the loan). These type of mortgages are good for people who may not have great a credit score or less steady income. The most common types of government-backed mortgages come from the Federal Housing Administration (FHA) and the Veterans Administration (VA). FHA loans are known to have lower down payments (as low as 3.5% of purchase price) and can be easier to qualify for. However, there is a maximum loan limit and you’ll need to pay a mortgage insurance premium (MIP) which contributes to the Mutual Mortgage Insurance (this is where the FHA draws from to pay lender’s claims when borrower’s default). VA loans are given out only to veterans, current members of the U.S. armed forces, reservists/national guard members, or eligible surviving spouses. You can get a VA loan without any down payments and there are no insurance requirements. However, borrowers do have to pay a funding fee (a one-time charge between 1.25 – 3.3% of the loan amount). Other loans can come from the Rural Housing Service (RHS), USDA, and First-Time Homebuyer programs.
- Conventional Loans: Mortgages that are not insured by the government, meaning the government won’t cover the cost if a borrower defaults on payment. Generally you’ll need good credit and a steady income to qualify for these loans. If you can’t put down at least 20% on the down payment then the lender will require you to pay for private mortgage insurance (PMI). The PMI ensures that the insurance company will pay the lender in full if you default on the loan.
Furthermore, conventional loans usually fall into two categories: conforming and non-conforming loans.
- Conforming loans: These must meet the loan limit guidelines set by government-sponsored mortgage associations Fannie Mae and Freddie Mac. For example: the loan limit of a single-family home in 2018 is $453,100. Areas with higher priced housing markets will have higher loan limits. The benefit of getting a conforming loan is that for borrowers with excellent credits, the lenders will usually offer a much lower interest rate!
- Non-conforming loans: These are loans that do not meet the loan limit guidelines and therefore cannot be purchased by Fannie Mae or Freddie Mac and resold on the secondary market. Examples of non-conforming loans include jumbo loans which exceed the conforming loan limits and have different underwriting guidelines. Jumbo loans come with more risk and higher interest rates to protect lenders – you’ll also need to make a larger down payment (at least 20%) to qualify for one. However, the benefit is that you can end up borrowing a lot more than typical conforming loans. Jumbo loans are generally for high-income earners who have good credit and lots of assets. Other non-conforming loans include those made to borrowers with poor credit, high debt, or recent bankruptcies. Summary: You’ll need to pay more interest rate – so try to keep the amount you borrow below the conforming loans limit.
Next time, we’ll discuss other important terms you should consider when it comes to choosing a specific mortgage plan.