If buying a home is something you’re considering, you might be curious about the different types of mortgages that are available to you. After all, the interest rate on your loan could have a huge impact on your finances over time, saving you thousands of dollars.
In today’s post, I’m going to demystify the home loan by explaining the most common types of mortgages. That way, you’ll be able to approach a lender with a bit of context and knowledge to help make the best mortgage decision for you and your family.
The most common types of home loans in the United States today are fixed-rate mortgages. A fixed-rate mortgage has the benefit of stability in terms of its interest rate--year after year, or the lifetime of your loan, you know exactly what percent of interest you’re going to pay.
Fixed-rate mortgages most frequently come with repayment terms of 15 or 30 years. However, some lenders offer different repayment periods.
As with any debt, paying off a mortgage in a shorter term typically amounts to paying less interest over the lifespan of the loan. For this reason, buyers who can afford higher monthly mortgage payments often opt for a 15-year fixed-rate mortgage.
If you can’t afford higher monthly payments, a 30-year loan will typically have lower mortgage payments, but at the expense of paying more interest over the life of the loan.
The 30-year option is the most often in the United States, where first-time buyers typically have too many other monthly bills to afford a high mortgage payment.
Adjustable-rate mortgages (ARMs) were once an ideal option for first-time buyers who could purchase a home at a very low interest rate and then refinancing once that rate was set to rise. However, after the housing crisis of 2007, trust in the housing market drastically declined.
In recent years, ARMs have begun to make a comeback. However, they currently still only account for around 5% of home loans.
Adjustable-rate mortgages come with one important advantage and one huge disadvantage over fixed-rate mortgages. The upside is the ability to borrow money for a home at a lower interest rate than other mortgage types. The down side? Your interest rate isn’t locked in for the length of the loan, meaning your rate could, in theory, rise dramatically before you sell or pay off the home. This is exactly what happened to borrowers during the subprime mortgage crisis.
There are a number of special loan programs that have been sponsored by the government over the years. Among them are USDA rural development loans, VA loans for veterans and their spouses, and FHA loans offered by the Federal Housing Authority.
All of these loans make it easier to buy a home with little or no down payment or a credit score that’s less than perfect. That makes these options great for first-time homeowners.
If you’re in the market to buy a home, you’re probably learning many new vocabulary words. Pre-approved and pre-qualified are some buzz words that you’ll need to know. There’s a big difference in the two and how each can help you in the home buying process, so you’ll want to educate yourself. With the proper preparation and knowledge, the home buying process will be much easier for you.
This is actually the initial step that you should take in the home buying process. Being pre-qualified allows your lender to get some key information from you. Make no mistake that getting pre-qualified is not the same thing as getting pre-approved.
The qualification process allows you to understand how much house you’ll be able to afford. Your lender will look at your income, assets, and general financial picture. There’s not a whole lot of information that your lender actually needs to get you pre-qualified. Many buyers make the mistake of interchanging the words qualified and approval. They think that once they have been pre-qualified, they have been approved for a certain amount as well. Since the pre-qualification process isn’t as in-depth, you could be “qualified” to buy a home that you actually can’t afford once you dig a bit deeper into your financial situation.
Getting pre-approved requires a bit more work on your part. You’ll need to provide your lender with a host of information including income statements, bank account statements, assets, and more. Your lender will take a look at your credit history and credit score. All of these numbers will go into a formula and help your lender determine a safe amount of money that you’ll be able to borrow for a house. Things like your credit score and credit history will have an impact on the type of interest rate that you’ll get for the home. The better your credit score, the better the interest rate will be that you’re offered. Being pre-approved will also be a big help to you when you decide to put an offer in on a home since you’ll be seen as a buyer who is serious and dependable.
Although getting pre-qualified is fairly simple, it’s a good step to take to understand your finances and the home buying process. Don’t take the pre-qualification numbers as set in stone, just simply use them as a guide.
Do some investigating on your own before you reach the pre-approval stage. Look at your income, debts, and expenses. See if there is anything that can be paid down before you take the leap to the next step. Check your credit report and be sure that there aren’t any errors on the report that need to be remedied. Finally, look at your credit score and see if there’s anything that you can do better such as make more consistent on-time payments or pay down debt for a more desirable debt-to-income ratio.
Preparing to buy a home is a long and stressful process for many. You’ve spent months, or even years, saving for a down payment, planning your future, and building your credit to ensure you get the best possible interest rate on your loan.
Then you find out, when getting preapproved for a mortgage, that your credit score dropped by a few points. So, what gives?
There’s a lot to understand about how credit scores affect mortgages and vice versa. In today’s post, I’m going to attempt to cover everything you need to know about how applying for a mortgage can affect your credit score so you’ll be prepared when it comes time to buy a home.
There are a lot of misconceptions about what it means to be preapproved or prequalified for a loan. Some of it is due to the jargon that is used in real estate transactions, and some of it is just a marketing technique on the part of lenders.
So, what does it mean to be prequalified and preapproved?
The short version is that getting prequalified is a quick and easy process to determine whether you’re eligible to lend to and how much you’re likely to receive. It involves a quick review of your finances, and often includes either a self-reported or soft credit inquiry.
A “soft inquiry” is the type of credit check that employers typically use for a background check. It doesn’t affect your credit score, as you are not applying to open a new line of credit. In fact, many lenders’ process for prequalification is a simple online form that doesn’t even require a credit check. We’ll talk more about the difference between soft inquiries and hard inquiries later.
The simplicity of prequalification makes it a simple and easy way to get started. But, it isn’t always accurate in how well it predicts the type of mortgage and loan amount you can receive. That’s where preapproval comes in.
When you get preapproved for a loan you fill out an official application (you often have to pay for these). This will request documentation for your finances and assets, and will ask your approval to run a detailed credit report.
These credit reports are considered “hard inquiries” and are a vital step in getting approved or preapproved for a mortgage. However, they also, at least temporarily, lower your credit score.
When any creditor, be it a bank or credit card company, is determining whether to lend to you, they want to know that you are a safe investment. To determine this, they want to know how frequently you pay your bills on time, how much you owe to other creditors, and how financially stable you are right now.
When you make multiple inquiries in a short period of time, it’s a red flag to lenders that you might be in trouble financially. Thus, hard inquiries will lower your credit score for 1 to 2 months.
When borrowers apply for a mortgage, they often shop around and apply to multiple lenders. While it may seem that all of these hard inquiries will add up and drastically lower their credit score, this isn’t the case.
Credit bureaus take into account the source of the inquiries. If they realize that you are applying for mortgages, they will typically recognize this as rate shopping and group these applications together on your credit report, counting them only as a single inquiry. This means your score shouldn’t drop multiple times for multiple mortgage preapprovals that were made within a small time frame.
Now that you know more about how mortgage applications affect your credit score, you can confidently shop around for the best mortgage for you and your family.
For the generation that grew up at the height of the subprime mortgage crisis, buying a home is a scary concept. Many young people in the 18-34 age range are dealing with high rent, a poor job market, unpaid internships, and student loans the size of a home loan. Yet, others are finding their footing and realizing that owning a home is advantageous in the long run. If you're thinking of delving into the world of home ownership for the first time here's a crash course in Home Buying 101.
A mortgage could put you on the hook to a lender for longer than a decade. The last thing that you want to do is to enter a financial relationship with the wrong mortgage lender. Engage the wrong mortgage lender and you might enter a legally binding agreement with a company that is on the brink of financial ruin.
Why you may want to hold off on signing that mortgage
Even if the wrong mortgage lender is solvent and not at risk of steep financial challenges, there could be negative fallout. An inexperienced lender might not perform sufficient due diligence to prevent unscrupulous workers from being hired by their organization.
If they don't, your financial data could be at risk. Other reasons why you may want to hold off on signing that mortgage, especially if doing so legally binds you to the wrong lender include:
Why just getting a house is not enough
You might not have hit the bull's eye even if you found a lender to approve you for a mortgage. In fact, you might have just stepped into a business venture that could force you to pay more for your house within five years.
That may happen if you allowed a mortgage lender to talk you into signing a variable rate mortgage. If you've ever had your student loans balloon after a grace period ended or interest rates climbed, you know the pain of having to deal with an unexpected payment increase.
Misuse of your personal and financial records is another negative that might result from entering a mortgage deal with the wrong lender. At the worst, you could become a participant in a Ponzi scheme. This could happen even if you enter a deal with a relative or friend who works in the housing or financial industry.
Protect yourself by performing the same level of due diligence that a home loan provider performs on you. Check financial performance, mortgage interest rates and the types of mortgages that lenders normally go with. For example, you could find out if a lender generally takes risks with subprime mortgages. Also, and this applies to any deal, trust your gut and avoid putting on blinders simply because you want a certain house right now.
