House shopping can be a thrill (not to mention a little stressful). And once you find the right place, it'll be time to seal the deal by securing a home loan. But you might be asking, "Where do I start? What kind of home loans are available and which type is best for me?" We tackle these questions and more with an overview of the world of mortgages.
If you're like 99 percent of the population, you don't have a suitcase full of large-denomination bills to pay for your new pad upfront. The overwhelming majority of us will need to get a home loan and begin paying off the property over time. And in the weltering sea of financial loans, there are, what seems to be, an infinite number of mortgage types.
But understanding mortgages doesn't need to be so unnerving. Generally speaking, home loans can be broken down into 2 main categories — "conventional" mortgage loans and "government-insured" mortgage loans. Under each, there are different types of loans that we'll discuss further.
conventional mortgage loans
Simply put, a "conventional" loan is a type of mortgage that is not insured or guaranteed by the federal government. So if you were to stop making your mortgage payments, the lender could be left in the lurch. To reduce this risk, lenders often require a 20 percent down payment — or private mortgage insurance for anything less than 20 percent — to assure you're a serious buyer.
Conventional mortgages come in the form of either fixed-rate or adjustable-rate mortgages (or a combo of the 2). And regarding the size of the loan, they might be either "conforming" or "non-conforming".
As its name suggests, this kind of loan will remain at both a "fixed" interest rate and monthly payment throughout the full loan period. That means payments will never change, month after month, year after year. Fixed-rate loans are typically available for either 30- or 15-year periods. Depending on your needs, there are advantages and disadvantages when it comes to fixed loans.
- Advantages: The main benefit of a fixed-rate mortgage loan is that you know exactly what you're committing to financially — which is why they're the most popular. This is especially advantageous for homeowners looking to settle down in an area for the long haul.
- Disadvantages: If you're paying for private mortgage insurance instead of the 20 percent down payment, a fixed-rate mortgage loan may not be all that great, as it'll increase your annual percentage rate (APR) significantly. On top of that, fixed-rate mortgages typically necessitate higher interest rates to sustain the unchanging payments.
Unlike its counterpart, adjustable-rate mortgages (ARMs) have interest rates that do change. An ARM will remain fixed for an initial period — typically 3, 5, or 7 years — after which it'll "adjust" every year moving forward. That's why it's often referred to as a "hybrid" loan. Once again, whether or not you should opt for this type of mortgage is contingent upon your unique circumstances:
- Advantages: If you're just trying to flip a house (i.e. purchasing property, spending a small sum to fix it up, and selling it for more), then an ARM may be up your alley. The initial 3, 5, or 7 years of fixed rates will likely be lower than that of a straight 30-year fixed-rate loan discussed above. In other words, if you know you'll be in and out of there before the fixed-rate period is up, then an ARM could be advantageous.
- Disadvantages: If for some reason you weren't able to leave the place within a 3-, 5-, or 7-year period, then you might be faced with financial uncertainty — meaning, an unknown mortgage interest rate for, say, the next 30 years. The marketplace can be volatile, and it's possible that the interest rate could furtively increase throughout the life of the loan period.
Conforming versus non-conforming loans
A "conforming" loan satisfies guidelines established by Fannie Mae and Freddie Mac — government sponsored entities that drive the mortgage market. The most popular guideline is the size of the loan, whose maximum limit is $417,000 in most counties (and higher in states like Alaska, California, and Hawaii). Conforming loans are popular because they usually have lower interest rates and fees.
Non-conforming loans are those that are above the conforming limit ($417,000). These loans usually include higher interest rates and require a down payment of 20 percent or more. So if you live in a locale where the conforming loan is $417,000 and you take out a single mortgage for $500,000, you'd have to opt for the non-conforming loan.
Although Fannie Mae and Freddie Mac are now controlled by the government, these types of loans are not government loans.
government-insured mortgage loans
Home loans insured by the government are designed to accommodate people that may not qualify for a conventional mortgage loan. Types of government-insured loans include the following:
Federal Housing Administration (FHA) loans
FHA loans are insured by — you guessed it — the FHA, and can be issued by any FHA-approved lender. There's usually a minimum 3.5 percent down payment required (compared to the 20 percent by a conventional loan) and a credit score of between 500 and 700. Plus, FHA loans generally have lower closing costs and lax credit-qualifying criteria.
It should be noted, however, that FHA-approved lenders typically have varying thresholds for risk, and therefore set their own guidelines on top of FHA guidelines.
Veterans Affairs (VA) loans
Backed by the Department of Veteran Affairs, the VA loan is reserved for veterans and their families. There's no down payment required, which means the Veteran Affairs department will reimburse the lender if individuals default or skip out on payments. Because VA loans aren't available to every veteran, you can contact the Regional Loan Center in your area to learn more about eligibility.
United States Department of Agriculture (USDA) loan
A USDA loan is aimed at those living in rural areas. If you're unsure whether you meet the location requirement, feel free to visit the United States Department of Agriculture site, where it lists qualifying counties, as well as income stipulations.
get homeowners insurance before closing
Most mortgage lenders require you to have homeowners insurance before closing to financially protect what's technically their property until the house is paid off. And it's well worth it — a homeowners policy from Esurance, for instance, helps protect you against a number of hazards including fire and lightning, hailstorm damage, windstorms, theft and vandalism, smoke damage, falling trees, busted HVACs, civil upheavals, and more. Plus, if your home were ever rendered uninhabitable by a covered peril, additional living expense coverage helps pay for temporary housing.
When you get your fast, free homeowners insurance quote from Esurance, make sure you check out the rest of our wide assortment of customizable coverage options and nifty money-saving discounts. You can also give us a call at 1-866-439-5633, where our licensed agents are available at these times to answer any of your questions.
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